Common Carrier Bureau officials told us that they believed an examination of AT&T's productivity and efficiency would be a worthwhile endeavor. In this regard, the Economics Division Chief and Economic Studies Branch Chief stated that while such an investigation may not lead to the development of any hard and fast productivity measures, they believed that it would nonetheless be valuable in assessing the effects of regulation on AT&T's performance. A Division economist involved in rate of return activities believed, however, that FCC could come up with productivity and efficiency measures to be used in regulating AT&T. 1/ FCC's monitoring of the rate of return--what policy is appropriate? In addition to establishing a fair rate of return for AT&T in formal rate of return proceedings, FCC also attempts to monitor the carrier's realized rates of return between rate proceedings. Various other financial information is also collected. The aim of the activity is to determine whether AT&T has exceeded its authorized rate of return or whether changes in cost of capital necessitate the initiation of a rate proceeding if, for example, a significant drop in the cost of capital should occur. In 1979, an occurrence took place which focused attention on this function and raised questions concerning the policies which FCC should follow in carrying out its rate of return responsibilities. This was FCC's determination that AT&T had apparently exceeded its authorized rate of return in 1978. AT&T's 1978 excess earnings In early 1979 FCC determined that AT&T appeared to have exceeded its authorized rate of return as specified in Docket 20376. In that Docket FCC had authorized AT&T an overall rate of return of 9.5 percent plus an additional 0.5 percent which could be achieved through increased productivity and efficiency. According to FCC a report issued by AT&T in January 1979 showed its ratio of net earnings to average net investment for 1978 was 10.22 percent. FCC stated that this equated to an excess earnings of $99 million above the authorized 10 percent maximum. Further study of the matter led to questions, however, concerning whether the figure contained in the report was accurate or whether a different figure was correct. In October 1979, FCC issued a notice of inquiry into the excess earnings issue. In the notice FCC asked for comments on the following questions: 1/Common Carrier Bureau officials told us in July 1981 that they plan to explore carrier productivity and efficiency in connection with the application of FCC's section 214 authority. This issue is to be taken up in a planned extension of the Competitive Carrier Rulemaking (Docket 79-252). --What is the appropriate time period over which FCC should consider AT&T's earnings--a calendar year or some other period? --What measurement of AT&T's rate of return should FCC use? --Had AT&T exceeded its authorized rate of return for 1978 --What action, if any, should FCC take regarding any excess earnings? In the notice, FCC also discussed more broadly the policies it should follow in those instances in which carriers earn above their allowed rates of return. For example, FCC questioned whether the rate of return prescription should be viewed solely as a "target" earnings rate which individual tariffs would be designed to achieve and, if so, whether it should prescribe tariffs if the earned rate of return varied from the prescribed rate of return. It also asked whether a rate of return prescription should provide an upper limit to the earnings of a common carrier with any excess revenues being returned to ratepayers. As of August 1981, the Commission had yet to issue a decision on what action it will take regarding the excess earnings. Some FCC officials we spoke with, in this regard, believed that a lack of Commission action on this proceeding could undermine the credibility of their rate of return regulatory program. FCC's REVIEW OF RATE BASE AND EXPENSE ITEMS FCC's efforts to review rate base and expense items during the past decade have focused around a single proceeding--phase II of Docket 19129. In this Docket FCC attempted to formally and comprehensively investigate AT&T's rate base and expenses as well as other aspects of its operations. Both before the initiation and after the termination of this Docket, FCC has instead used an informal "continuing surveillance" approach for rate base and expense analysis. Under both approaches FCC has experienced considerable difficulty in establishing any meaningful oversight over AT&T's operations. Continuing surveillance Several years after its creation, FCC adopted a program of continuing surveillance to use in regulating interstate telephone rates. This program was designed to use informal negotiation between the FCC and AT&T in lieu of formal rate cases. quired AT&T to submit various reports and applications to the Commission, including applications to construct interstate facilities. In addition, FCC maintained field offices which were responsible for interpreting and monitoring compliance with accounting requirements and prescribing depreciation rates. In October 1965, however, the Commission began a formal investigation into AT&T's charges for interstate and foreign communications services. It initiated Docket 16258 which was intended to examine a wide range of matters, including the rate of return required by AT&T, the amounts properly includable as rate base and expense items, and other aspects of AT&T's operations. Docket 16258 ultimately did encompass an investigation of AT&T's fair rate of return; however, a formal review of rate base and expense items was, in effect, postponed to a subsequent proceeding--Docket 19129, phase II. Docket 19129--phase II Docket 19129 was initiated on January 20, 1971, to investigate the lawfulness of the charges of AT&T and its associated companies for interstate and foreign communications service. The investigation was divided into two phases. Phase I was limited primarily to the determination of a fair rate of return on AT&T's interstate services. Phase II was aimed at other aspects of AT&T's operations, including an investigation of AT&T's revenue requirement. 1/ There were approximately 50 FCC staff conducting the investigation--consisting of Common Carrier Bureau personnel and part-time consultants. AT&T supplied the staff with over one million pages of documents and internal records during the investigation. Hearings were also held periodically during 1974 and 1975 during which some 16,000 pages of transcript were recorded and almost 16,000 pages of exhibits presented. In addition, FCC awarded several outside contracts to study AT&T operations. Cost of participation were, according to FCC, approximately $4 million for the FCC Trial Staff and almost $6 million for AT&T. The overall proceeding lasted over 6 years. An initial decision was issued by the presiding FCC administrative law judge in July 1976 and the Commission's final decision was adopted in February 1977. FCC's investigation of AT&T's revenue requirement included an examination of various plant and expense accounts as well as a review of such items as AT&T's construction program, the utilization of the interstate telephone network, and AT&T's internal audit program. In carrying out the investigation, FCC did not, however, attempt to perform a complete audit of AT&T. Therefore, 1/The two other major areas considered in phase II dealt with (1) the relationship between Western Electric and the rest of AT&T and (2) AT&T's long-distance (MTS) rate structure. the dollar amounts reported by AT&T for its plant items were generally accepted as accurate. 1/ Lack of past oversight hampers FCC's investigation In spite of the time and effort expended during phase II FCC experienced considerable difficulty in determining the reasonableness of AT&T's rate base and expense items--particularly those involving the largest expenditure of funds. As recognized by FCC throughout the proceeding, these problems were greatly compounded by the lack of previous FCC oversight of such items under its continuing surveillance program. This is clearly illustrated by FCC's attempts to deal with AT&T's construction program, its utilization of the interstate network and its maintenance expenses. 2/ AT&T's construction program FCC's investigation of AT&T's construction program during phase II revealed that past regulatory oversight had been inadequate and more extensive review would be required in the future. In his initial decision in phase II, the presiding administrative law judge concluded that neither FCC nor State public utility commissions had exercised the necessary scrutiny over AT&T's construction expenditures. This dearth of review of construction expenditures by the responsible regulatory agencies, he believed, precluded them "from acting responsibly and decisively to problems as they arise." In this regard, he added that reviews by most State commissions were, at best, little more than informal discussions between commission staffs and company personnel and that FCC review was, seemingly, even less in depth. In its final decision, the Commission agreed that more effective review of the construction program was needed in the future. Network utilization The inadequacy of past FCC review also hampered the Commission's ability to deal in Docket 19129 with problems relating to AT&T's utilization of the interstate telecommunications network. 1/During the test year of 1972 used in phase II, AT&T's interstate rate base, as specified in the Commission's final order, totaled approximately $15.4 billion and its expenses approximately $5.3 billion. In 1980, AT&T's interstate rate base and expenses, including taxes, totaled approximately $29.2 billion and $13.7 billion, respectively. 2/FCC's actions and problems relating to various other rate base and expense items are discussed in appendix VIII. Issues relating to AT&T's depreciation expense and its costs for installing telephones and other station apparatus are discussed in chapter 7. While the record established during the proceeding indicated that the network had been underutilized during the test year of 1972, FCC declined to take retroactive action since it believed its own lack of oversight placed with it some responsibility for the problem. Again FCC called for increased future oversight. Because AT&T's efficiency in using the interstate toll network directly impacts its rate base, regulatory oversight is needed to ensure that the network operates at its lowest cost and most efficient level. Such oversight includes a review of service standards and utilization objectives developed by AT&T and its adherence to them. If service standards are too high or network utilization too low, an over-investment in facilities would occur which would, in turn, increase the carrier's rate base and revenue requirement. If, on the other hand, service standards are too low or utilization too high, service problems could occur. Among other things, this could result in increased congestion of facilities, particularly during hours of peak usage, which would reduce a customer's ability to successfully complete a telephone call. In Docket 19129, FCC questioned both the utilization objectives established by AT&T and its actual utilization of the network. It noted, in this regard, that AT&T had not justified its network utilization standard as being reasonable for effective utilization of its interstate toll network. FCC also asserted that actual utilization of the network had been far below even the objectives which AT&T had set. To compensate for this underutilization, the staff had recommended to the administrative law judge a disallowance of $305.7 million from AT&T's rate base. While AT&T did not dispute the conclusion that the network had been underutilized, it argued that such underutilization had occurred because high growth rates in demand for service which had been forecast did not materialize. In its decision the Commission accepted the conclusion that the interstate telephone network had been underutilized; however, it determined that a retroactive disallowance of funds in the rate base should not be made. The Commission stated that while AT&T was partly responsible for the underutilization, because of its responsibility for facilities authorization under section 214 of the Communications Act, 1/ it must also bear a portion of the blame. In this regard the presiding administrative law judge had noted that neither the Commission or its staff had ever conducted an in depth study of network utilization. Thus, he believed retroactive criticism in this matter was warranted only on a showing of arbitrary or capricious management. 1/Under section 214, before constructing or extending a communications "line," carriers must obtain from FCC a certificate that such action serves the public convenience or necessity. |