For the Association of American Railroads, a Brattle expert reviewed the methodology relied upon by the Surface Transportation Board (STB) to determine the cost of equity for U.S. freight railroads, and provided expert testimony regarding the appropriateness of the methodology. Our testimony focused on the implementation of the Capital Asset Pricing Model and the cash-flow based three-stage DCF model along with a discussion of the merits and regulatory practice of using multiple methods to determine the cost of equity. For the Capital Asset Pricing Model our work focused on the appropriate market risk premium, where the STB concurred with us that the historical average MRP was a reasonable benchmark. For the DCF model, we showed that the existing model underestimated the cash flow that accrue to railroads, so the opposing party’s argument that it overstated the cost of capital was flawed. The STB accepted our recommendation to continue estimating cost of equity by assigning 50% weight to the Capital Asset Pricing Model using well-specified parameters including the average historical market risk premium and 50% weight to the cash-flow based multi-stage DCF model developed by Ibbotson. The STB thus accepted our recommendation and ultimately declined the opposing party’s appeal citing in part our work.

Practices