Statistics Canada ( Quarterly Financial Statistics for Enterprises ). Statistics Canada started reporting quarterly return on equity data in 1980, and has yet to update this series to either 1999 or 2000. Schedule 13 graphs this ROE data with the spread between the yield on CBRS rated
BBB debt and long Canada bonds. It shows that as of 1980 the average ROE was 15.05% and the yield spread that rewards investors for holding BBB rated debt instead of default free Canada bonds was just over 50 basis points. “Corporate Canada’s ROE” then declined during the 1982 recession as the yield spread widened. The ROE then hovered around the 10% level during the growth oriented 1980's with a stable yield spread. As roes fell from 1989 onwards, investors grew concerned about credit risk and the yield spread increased dramatically to almost 350 basis points in 1993. The profit recovery during the mid 1990s then caused the yield spread to contract.
The graph in Schedule 13 indicates the way in which the business cycle affects firms. During expansions, profitability increases and credit risk is lessened causing investors to buy corporate bonds on narrower spreads over similar Canada bonds. During recessions the reverse happens: as profitability is reduced credit risk tends to increase causing spreads to widen. Profitability in this sense affects the market excess of cyclical firms. In contrast to competitive firms, ROE regulated firms have much more stable earnings. Consequently, even during recessions they have access to capital markets on reasonable terms.
The following table gives the yield spread on CBRS Utility and Non-Utility indexes.
CBRS Non-Utility Less Utility Yield Spreads
A+ A BBB
1989 15 8 -9
1990 18 0 6
1991 -8 -18 17
1992 49 48 138
1993 145 36 271
1994 68 36 105

A positive value in the first column, for example, means that in 1989 non-utility A+ rated debt yielded on average 15 basis more than A+ utility debt. The rating categories run from the effective best in Canada, A+ to the lowest investment grade, which is BBB.
1
Within the grade there are sub grades, for example A-, and firms often trade as A- before being upgraded from
BBB to A. However, we would expect that the yield spread would average out to zero, that is non-utility A bonds would yield the same as utility A bonds. As can be seen in the above table, this was not the case during the last recession. As the economy weakened in 1990 and 1991 and hit bottom in 1992 concern over credit risk heightened and spreads widened dramatically. From
1992-1994 non-utility issuers saw a dramatic widening of their spreads compared to “equivalent” utility issuers. In many cases they found it difficult to raise capital on reasonable terms.
However, as the CBRS data shows, utility issuers were not affected to the same degree and the capital market financed utility debt at lower yields across all rating categories during the last recession. Effectively, as in the recent BC Gas equity example, a “flight to quality” often makes it easier for utilities to raise capital during weaker economic times than non-utilities.
The profitability data also allows us to assess the argument that regulated firms should be allowed a return equivalent to what other companies earn on their book investments. This is commonly referred to as “comparable earnings.” We are dubious about such a proposition, since the selection of firms that go into the comparable sample is largely a matter of judgement with enormous potential for abuse. Moreover, the average return of any sample of firms over some arbitrary time period is only loosely, if at all, related to a fair rate of return. However, the data on overall corporate ROEs indicates that Corporate Canada has earned just above 6% over the period ending 1998. Even if we “update” for the higher profits in 1999 and 2000, the data would still only suggest 8.0-10.0% as a fair ROE.
2
1
There were and still are very few AAA rated corporate issuers to the extent that CBRS stopped calculating AAA-rated average yields.
2
Over the period 1991-2000 pre tax profits averaged 8.34% of GDP. The recent (1994) average corporate
ROE at this level of pre-tax profits was about 7.0% and in 1983 it was in the mid 9.0% range.