Dr. Booth’s Responses to the Regie’s Information Request No.1
RATE OF RETURN ON EQUITY
2.
References: (i)
(ii)
(iii)
(iv)
Item C-1-8, ACIG–6, document 1, pages 31-32, lines12-14 and
1-2 ;
Item C-1-8, ACIG–6, document 1, page 4, lines 28-29 ;
Item C-1-8, ACIG–6, document 1, page 5, line 1 ;
Item C-1-8, ACIG–6, Append F, page 1, lines 14-17.
Preamble:
Reference (i)
« The following table shows the stock market losses as of October 24, 2008 at the peak of the
financial crisis. At that time from a US perspective year to date the best performing stock market
was Japan’s which was only down 35%, the worst among the majors was Hong Kong at 58%, not
counting Russia’s, which was off 75% before they closed the market. Globally about $14 trillion
in wealth had disappeared in a few weeks. »
Reference (ii)
« The US credit crunch exacerbated a normal cyclical recession and caused the biggest stock
market crash for 70 years and fears of a Great Depression II. »
Reference (iii)
« This stock market crash has been traumatic. »
Reference (iv)
« Like the Canadian data in Appendix E including 2008 data dramatically lowers the
experienced market risk premium since the S&P500 total retum for 2008 was - 37% while the
decline in the long US Treasury bond yield from 4.35% to 3.18% generated very large capital
gains from holding US govemment bonds.» [emphasis added]
Questions:
2.1
Given the stock market correction of 2008, how are such events taken into account by
investors in their yield expectations? Do you believe that investors in 2009 require a
premium for higher or lower risk than in 2007? Please justify your answer.
2.2
As outlined in Appendix F, the combination of the worst stock market since the „30s and
the exceptional increase in the bond market “dramatically” reduces the premium for
market risk estimated using the historical average. Should we, on an exceptional and
temporary basis, exclude 2008 data from the historical average to better reflect the current
requirements of investors with respect to the risk premium in the market? Please
comment.
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Answer 2.1 From basic financial theory Dr. Booth believes that risk premiums are timevarying: they tend to increase during recessions and fall during booms as both the level of wealth
and confidence varies. One indication of this is the flow of money into and out of mutual funds as
the “small” retail investor enters and leaves the market. However, the markets are now dominated
by institutional and not retail investors making inferences based on an individual‟s psychology
etc perhaps less relevant than in the past. To illustrate Dr. Booth provides a recent strategy report
from the Royal Bank (jul29sw.pdf) which focuses on the increased “risk appetite” of the market
over the last three months since recovery set in during March 2009. The first paragraph of that
report states:
This indicates that whereas there was extreme risk aversion in the market (avoidance of risk at all
costs) prior to March 2009, since then the risk appetite has increased significantly as investors
have piled into the riskiest stocks and been amply rewarded. In fact the recovery from March 9,
2009 has been one of the fastest and largest recoveries in history as investors have accepted that
the worst of the recession is over and are afraid of missing the continuing rally in the stock
market. For example CNBC in the US stated on August 7, 2009:
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Stocks Surge To New '09 Highs
Posted By:Lee Brodie
STOCKS SURGE TO NEW ’09 HIGHS
Afraid of missing the next leg higher, investors poured back into stocks on Friday sending the
S&P 500 [.SPX 1010.48
13.40 (+1.34%) to a new high for 2009. A better-than-expected jobs
report fueled hopes of an economic recovery and suggested the recent market run-up was on
solid ground.
For the week, the Dow was up 2.2 percent, the S&P 500 was up 2.3 percent and the Nasdaq was
up 1.1 percent.
With the bulls large and in-charge how should you be positioned?
Considering the market action, I think we could easily see 1050 on the S&P, muses Steve
Grasso.
The bullishness was generated by the part of the jobs report that showed manufacturing was
improving, adds Joe Terranova. Investors liked the strength and that’s what sent stocks higher.
There’s also a lot of put protection in the market, says Pete Najarian. That actually gives
investors more confidence (because losses are limited) and they become okay with taking more
risk.
Dr. Booth believes that this crisis was caused by poor regulation of US financial institutions that
generated a global credit crunch, which until Lehman Brothers was allowed to fail, no-one
anticipated. However, in many ways financial problems are easier to solve than operating
problems, since it is mainly a question of accepting write offs on asset values, which has now
largely happened. Since the US guaranteed their largest banks and stress tested them, the market
has rebounded very significantly and the real economy will follow with a lag, In Dr. Booth‟s
judgment risk aversion was at elevated levels from September 2008-March 2009, but that it is
now rapidly returning to normal levels as is also confirmed by bond market data. Dr. Booth
would judge the current situation as a normal recessionary one, rather than the fear from
September 2008-March 2009 that we could be in a Great Depression II. As such he would not
adjust his market risk premium estimate for normal cyclical events. Given the difficulty of
estimating the level of the market risk premium Dr. Booth believes that estimating changes in it
is hazardous.
Answer 2.2 No. The data is what the data is. We should no more exclude 2008 than the
previous five years when the return on the TSX was 9.83%, 17.26%, 24.13%, 14.48% and
26.72% for an average of 18.50%, which is clearly above market expectations and excessive.
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However what we should do is exercise judgment. Dr. Booth did not adjust his market risk
premium estimate of 5.0% downwards to reflect 2008 data and in fact has increased the “zone of
reasonableness” to take into account Fernandez‟ survey of Canadian academics that placed the
median market risk premium in Canada at 5.1% with the vast majority at either 5% or 6%. So far
year to date the TSX has earned 21.1% and the S&P500 11.87%, Dr. Booth believes that when
2009 data is added, the estimates of the market risk premium will increase back to the 5.0-6.0%
range that most academics believe is reasonable. So rather than adjust “hard” numbers by
selectively ignoring some, Dr. Booth suggests that the Regie rely on his professional judgment
and that of Canadian Professors of Finance as indicated in Fernandez‟s survey.
3.
References: (i)
(ii)
(iii)
(iv)
Item C-1-8, ACIG–6, document 1, page 42, lines 25-26;
Item C-1-8, ACIG–6, document 1, Schedule 12;
Item C-1-8, ACIG–6, document 1, page 43, lines 10-13;
Item C-1-8, ACIG–6, document 1, page 78, lines 21-23.
Preamble:
Reference (i)
« Schedule 12 shows spreads using the A and BBB spread data from the Scotia Capital long bond
indexes.»
Reference (ii)
The graph shows the differences in yield of long-term corporate bonds rated A and BBB, versus
long-term federal bonds since 1988.
Reference (iii)
« Second and more important is the fact that what is unique during the current period is the
dramatic increase in spreads experienced by A rated companies. During previous recessions and
crises A spreads reached 150 basis points, whereas in this crisis they reached 350 basis points
before their recent precipitous decline. »
Reference (iv)
« Regardless the panic in the bond market has passed and spreads are now back to the level that
are typical of serious recession rather than the levels of a few months ago that suggested that the
“sky is falling.” »
Questions:
3.1
Please provide historical data, dating back at least to 1960 (to cover the most possible
economic cycles) and in the form of an Excel file, concerning the yield rates of
Canadian long-term corporate bonds rated A, and the yield of Canadian federal
government bonds with the same maturity (10, 20 or 30 years). Please calculate and
provide spreads, calculate and provide the average yield spread and the standard
deviation for the whole period. Please describe in graphic form the spreads, the
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historical average of these spreads for the whole period, and indicate the limits
established by more or less one and two standard deviations.
3.2
Please provide the same historical data, dating back at least to 1960 and in the form of
an Excel file, concerning the yield rate of U.S. long-term corporate bonds rated A, and
the yield of U.S. federal government bonds with the same maturity (10, 20 or 30 years).
Please calculate and provide spreads, calculate and provide the average yield spread and
the standard deviation for the whole period. Please describe in graphic form the spreads,
the historical average of these spreads for the whole period, and indicate the limits
established by more or less one and two standard deviations.
3.3
Please provide historical data supporting the assertion that the yield spreads are now
back to levels typical of a serious recession. Specify and show what these spreads were
during the recession of 73-74, 81-82 and any period comparable to the current situation.
Please comment.
Answers 3.1& 3.3 Data provided as far back as is available in electronic format, which is
December 1979. Dr. Booth is aware that the Scotia Capital “A” bond yield data actually goes
back to August 1976 or another 3 years or so, but since that period does not cover a recession he
has not sought out that data to manually transcribed it. The average spread is 102 basis points
(bps) with a standard deviation of 45.2 bps and range from a minimum of 35 bps to a maximum
of 370 bps. A two standard deviation range around the average would be +/- 90 bps.
The current spread of 177 is slightly less than that reached in May 1982 of 183 bps and within the
+/- two standard deviation range where the limit would be 192 bps. This confirms Dr. Booth‟s
statement that the yield spreads are back to levels typical of a serious recession and down from
the recent high of 370 bps which indicated a “sky is falling” scenario. Note that normally A
spreads peak at lower levels than the 183 bps of May 1982. In the 2001-2 slowdown the peak was
150 bps and in the period 1989-94 122 bps. A graph of the spreads follows and is in the Excel
file.
A Spreads since 1980
400
350
300
250
200
150
100
50
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12/31/2008
12/31/2007
12/31/2006
12/31/2005
12/31/2004
12/31/2003
12/31/2002
12/31/2001
12/31/2000
12/31/1999
12/31/1998
12/31/1997
12/31/1996
12/31/1995
12/31/1994
12/31/1993
12/31/1992
12/31/1991
12/31/1990
12/31/1989
12/31/1988
12/31/1987
12/31/1986
12/31/1985
12/31/1984
12/31/1983
12/31/1982
12/31/1981
12/31/1980
12/31/1979
0
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Answer 3.2 Dr. Booth has not used US interest rate data in his testimony. However, in order
to be helpful he has sought out the following data back to 1947: US government long term bond
yields (FYGLT) and A rated (Moody‟s) corporate bond yields (FYAC). Dr. Booth is not familiar
with either of these series, but they are from the Citibank Data Bank, which he believes to be
reliable. Unlike the Canadian data which is weekly this data is monthly so should be slightly less
volatile. The average spread since 1947 is 127 bps with a standard deviation of 69 and a range of
33-385 bps. For the same period 1980-2009 the average is 152 bps and a standard deviation of 64
bps and a range of 76-386 bps. A two standard deviation range based on the same period is +/128bps. The latest spread data in the date bank is May 2009 which is 243 bps, which is within the
upper limit of the US average of 152 bps +128 bps or 280 bps.
A graph of the US spread data follows and is also in the Excel file
US A Spread
450
400
350
300
250
200
150
100
50
2008M05
2006M06
2004M07
2002M08
2000M09
1998M10
1996M11
1994M12
1993M01
1991M02
1989M03
1987M04
1985M05
1983M06
1981M07
1979M08
1977M09
1975M10
1973M11
1971M12
1970M01
1968M02
1966M03
1964M04
1962M05
1960M06
1958M07
1956M08
1954M09
1952M10
1950M11
1948M12
1947M01
0
Dr. Booth is cautious about using this US data since he is not familiar with it, but there are some
striking differences compared to the Canada data:
a)
The recession of the early 1990s hardly shows up which confirms his discussion
that the Canadian recession was more severe due to adjustments to Free Trade;
b)
The US spike in the early 1980s recession is more serve than in Canada where the
A spread hit 383 bps;
c)
The significant recession of the early 1970s and the panic of 1973 following the
Arab Israeli war clearly show up in A spreads spiking to 251 and 313 bps respectively.
4.
Reference:
Item C-1-8, ACIG–6, document 1, page 47, lines 7-10.
Preamble:
« Overall this Statistics Canada ROE data reinforces the aggregate profitability data that the top
of the business cycle was in 2007. For the whole period, 1988-2008 the average Statistics
Canada ROE for Corporate Canada was 9.1% and the median 9.88%. What this means is that
the average firm in Canada does not earn the level of ROE requested by Gaz Metro of 12.39%; »
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Questions:
4.1
Please describe the type of companies, business sectors covered and not covered, the size
and the total number of companies covered by the series of Statistics Canada used for
ROE.
4.1
Please explain how this series is representative of the composition of the S&P/TSX
generally used as a representative of the Canadian stock market.
4.2
Please compare the ROE of the S&P/TSX (and its predecessor, TSE300) with those
published by Statistics Canada for the period 1987-2008.
Answer 4.1 Dr. Booth‟s understanding is that this data comes from tax return data covering all
companies operating in Canada both public and private. It is obtained from the Canadian
Economic Observer where Statistics Canada divides Cansim series V634673 by Cansim series
V634628. The series are described as:
v634673 Canada; Total, all industries (excluding management of companies and enterprises and
other funds and financial vehicles); Net profit, seasonally adjusted (Dollars)
v634628 Canada; Total, all industries (excluding management of companies and enterprises and
other funds and financial vehicles); Total, equity (Dollars)
Answer 4.2 Dr. Booth does not claim that it is comparable to the S&P/TSX Composite. He
claims that it is representative of Corporate Canada since that is presumably why Statistics
Canada calculates it and presents it as a core statistic in the Canadian Economic Observer. Which
is more representative is difficult to argue either way; a strong case can be made that the firms in
the TSX60 at least are large powerful firms with market power and should not be compared to the
ROE of regulated utilities that are regulated to remove this market power. Note Dr. Booth
presents such data to show where we are in the business cycle and what is typical; not as a basis
for his recommendations.
Answer 4.3 Dr. Booth does not have access to the data going that far back. Normally corporate
data is only available on a rolling ten year window for current firms so checking for the TSX
back to 1987 and for firms that no longer exist is a major exercise. However, in FP Full coverage
ROE.xls is a file of all the current firms for which the Financial Post has full coverage for the last
ten years. The following graph is of the Statistics Canada data for the same period as for the
average and median of the FP data. Clearly the average is “pulled down” by the skewed nature of
some of the ROEs, so that the median is a better statistic. The correlation between the FP median
ROE and the Statistics Canada data is 0.95, but the median ROE for the FP firms is consistently
lower than that for the Statistics Canada data. Consequently Dr. Booth has no reason to believe
that the statisticians at Statistics Canada have made any mistakes or that their ROE data is “too
low” or unrepresentative of the ROE of Corporate Canada
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ROE for Corporate Canada
25.00
20.00
15.00
10.00
5.00
0.00
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
-5.00
-10.00
AVG
5.
References: (i)
(ii)
(iii)
Med
StatsCan
Item C-1-8, ACIG–6, document 1, page 51, lines 27-28 and table;
Item C-1-8, ACIG–6, document 1, page 53, note 12;
Item B-24, Gaz Métro, Responses to DDR #1, pages 95-96.
Preamble:
Reference (i)
« To illustrate, the betas for the major Canadian UHCs as well as the average (utility beta) for
each of the 5-year periods ending 1985 through 2008 are as follows: » Table of betas of 10
utility companies.
Reference (ii)
« Betas are estimated over five year periods of monthly data so the 1985 estimate covers the
period 1980-1985»
Reference (iii)
In response to question 26.2 Gaz Métro provides unadjusted β.
Questions:
5.1
The β of the companies provided by Dr. Booth on page 52 are significantly lower than nonadjusted β of Bloomberg, as furnished in response to the request for information made to
Gaz Métro, question 26.2. Please explain the difference.
5.2
Since β calculated from monthly data may not capture all the movements of securities and
the market as β calculated from weekly data, please indicate whether all β provided by Dr.
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Booth for the period 1985 to 2008 are calculated from monthly data. If yes, please explain
why Dr. Booth has preferred to use the monthly β rather than unadjusted Bloomberg β.
Answer 5.1 Dr. Booth does not use Bloomberg betas, but as far as he is aware Bloomberg
adjusts the actual betas by averaging them with the overall or grand mean for the stock market as
a whole which is 1.0. The normal justification for this is an article by Marshal Blume in the
Journal of Finance (June 1975) who put the adjustment down to measurement error. The essential
argument is that if you don‟t know anything about a stock then the best guess is that its beta is
1.0, that is, the grand mean. If you then observe a beta of 1.5 then that could be caused by either
permanent effects or a temporary event causing measurement error. If it is the latter then the beta
is an over-estimate and it will revert to the grand mean of 1.0. Hence the adjustment by weighting
what could be an over estimated beta of 1.5 with the prior estimate of 1.0. The opposite occurs
with a beat of 0.50.
However, in providing testimony before the Regie we are not dealing with a randomly chosen
stock about which we know nothing: we are dealing explicitly with utilities about which we know
a lot, so the Blume justification for adjusting betas has no validity since there is no expectation
that they will revert to 1.0. Instead the “prior” belief, if we know the stock is a utility, is not that
its beta is 1.0 but that it is the grand mean of all the utility betas which is about 0.50. This is the
Gambola and Kahl paper cited by Dr. Booth in footnote 14 (Gombola and Kahl, “Time series
properties of utility Betas,” Financial Management, 1990).
Adjusted betas, like Bloomberg‟s, have been rejected by other regulatory bodies such as the NEB
in its TQM decision where they stated on page 27 “The Board does not believe that TQM has
demonstrated that utility betas ultimately revert to one, an assumption on which adjusted betas
rely.”
Answer 5.2 This is a question of what is the correct interval over which to measure risk. The
question assumes that it is weekly, however, this depends on the investor‟s investment horizon
and Dr. Booth is not aware of any evidence that indicates that investors use a weekly time
horizon in investment planning. He would hypothesize that most investors use at least a monthly
horizon for when they receive their statements or more likely a quarterly horizon when
institutions are evaluated; what happens in between may, or may not, matter if it is not
“recorded.”
Dr. Booth uses monthly data since this is the way that almost all stock data is recorded in the
major data tapes. The standard way of estimating betas is then to use five years of monthly
observations since 60 observations gives reasonable statistical precision and balances precision
with the fact that betas may change for economic reasons. The monthly interval is because the
original data was manually collected by the Cowles Foundation going back at least to 1861 in the
United States. This price data can then be matched up with dividend payments to get monthly
total returns. As well as monthly data more recent data has been available on a daily basis so that
researchers can examine how the stock market reacts to corporate events such as a dividend cut.
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However, he does not believe that investors operate on a daily investment horizon. He is not
aware of vendors selling weekly series for stock prices.
In terms of Dr. Booth‟s reliance on his own estimated betas, he does this since he knows the
source of the data and that they are calculated in the standard way. If he were to unadjust
Bloomberg‟s betas that assumes that their original betas were estimated correctly from correct
data and he has no reason to believe that either assumption is correct. The same holds if he were
to use Royal Bank betas, Value Line betas, Yahoo betas, Merrril Lynch betas or anyone else‟s
betas.
6.
References: (i)
(ii)
(iii)
Item C-1-8, ACIG–6, document 1, page 69, lines 18-19 and 21-24;
Item C-1-8, ACIG–6, document 1, page 70, lines 17-18 and
note 23;
Item C-1-8, ACIG–7, document 1, Exhibit MPG-4, p.2.
Preamble:
Reference (i)
« No, regulated firms should be allowed to recover their issue costs in the allowed return in the
same way that issue costs attached to debt are included in the embedded debt cost. »
« These costs are made up of two kinds: the out of pocket reimbursement of expenses plus the
under pricing of a new issue to ensure a successful offering. Overall these costs run up to 5.0%
for a normal issue, although they can be smaller for larger issues since there are economies of
scale. »
Reference (ii)
«Once the tax deductibility of some of these costs is considered, a true "flotation or issue cost"
allowance of less than 44 basis points is reasonable plus the out of pocket expenses.»
« Note that with 5% issue costs, the idea is that the stock should sell at a market to book ratio of
1.053, so that it will net out book value on any new issue. With utility market to book ratios vastly
in excess of 1.052 it is difficult to rationalise any flotation cost allowance, since it is unlikely that
there will ever be any dilution. »
Reference (iii)
The "Dividend Metrics" table gives on line 12 the average payout dividend ratio, ranging from
55.2% to 59.6% between 2004 and 2008, with an average of 57.8%. This suggests that over 42%
of
profits are reinvested and are reflected in shareholders' equity as "retained earnings".
Question:
6.1
Does the calculation of issue costs (flotation cost) presented by Dr. Booth take into
account the fact that a large part of shareholders' equity is normally made up of retained
earnings and not the result of issuing shares? Please comment.
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Answer 6.1 Yes. As Dr. Booth discusses in his testimony (pages 69-71) the higher the
dividend yield the more a firm relies on raising new equity to maintain its financial structure and
as a result the higher the flotation cost adjustment. Conversely the lower the dividend yield the
more retained earnings and the lower the flotation cost adjustment. As Dr. Booth goes on to say
the major reason for this adjustment is to make sure the firm “nets out” book value in a new share
offering so there is no dilution. To the extent that shares sell substantially above book value the
motivation for any issue cost allowance is weak. However, Dr. Booth always recommends 50 bps
as a generic allowance since this seemed to evolve out of a compromise.
7.
Reference:
Item C-1-8, ACIG–6, document 1, page 78, lines 14-18.
Preamble:
Reference (i)
« For the above reasons my recommendation is to ignore the impact of any increases in bond
yield spreads on the ROE, since they do not indicate that the risk premium attached to investing
in bonds has increased. In my judgement a significant part of the increase in “A” spreads was
caused by the major banks liquidating their bond inventories in order to raise capital and
survive, particularly in the US. »
Question:
7.1
Is your analysis based on an analysis of the data? If so, please identify your sources
regarding the settlement of corporate bonds, specify the magnitude of sales of corporate
bonds by rating (AAA, AA, A, BBB) by the Canadian and U.S. banks during the 4th
quarter 2008 and 1st quarter of 2009 and please put these volumes into perspective with
the volumes of transactions of previous years.
Answer 7.1
answer:
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When Dr. Booth asked Mr. Engen of BMO for the data he was given the following
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The fact is that the only people who have the required data are the banks, and here even Scotia
Capital has stopped providing basic corporate bond yield data for publication in the Bank of
Canada Review. Quite amazingly after Mr. Engen refused to provide the data he asked Dr. Booth
for it!
Dr. Booth‟s analysis is based on the press reports of the Herculean efforts used by the Federal
Reserve Board in the US to try and create liquidity in the markets after they froze in mid
September and discussions with investment bankers. As he notes in his evidence these spreads
came down after the stability of the banking system had been assured which points to the pivotal
role played by the investment banks as market makers in the bond market. Also note that it is not
volume per se but how the transaction is made that affects liquidity. A $10 million bond trade
might have been made instantaneously in the summer (2008) because a bank was willing to buy it
and keep it on its books to sell later. However, after Lehman the same bank might only do an
agency trade, that is, try and match up the $10 million sale with other institutions willing to buy,
so the trade might have taken hours if not days because the bank was unwilling to take the risk
itself in a principal transaction. Either way the $10 million would be traded but the liquidity in
the latter transaction is much lower and the costs higher.
8.
Reference:
Item C-1-8, ACIG–6, Append E, page 3, lines 24-29.
Preamble:
Reference (i)
« In Schedule 1 are the results of a study of realised Canadian risk premiums over the longest
time period for which there is data available. The data is taken from an annual "Report on
Canadian Economie Statistics, 1924-2007," March 2008, compiled on behalf of the Canadian
Institute of Actuaries extended to include 2008 data. Over the entire period 1924-2008 an
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investment in equities would have eamed an average total rate of retum of 10.38% using the OLS
estimate, 9.64% using the geometric mean estimate, and 1l.31% using the arithmetic retum
estimate. The corresponding return estimates for the long Canada bond are 5.68%, 6.22% and
6.55%, producing corresponding market risk premium estimates of 4.70%, 3.42% and 4.76%. »
Questions:
8.1
Please provide in the form of Excel spreadsheet the data used to calculate the
historical averages in Canada and the results of these calculations.
8.2
Please provide in the form of Excel spreadsheet the same data used to calculate the
historical averages for the U.S. market and the results of these calculations.
8.3
Please specify in the context of increasing integrating of North American financial
markets, what weight should be given to Canadian and American statistics,
respectively.
Answers 8.1 & 8.2
Data provided as Booth Regie 8.xls
Answer 8.3 Dr. Booth‟s estimates of the market risk premium are not based on market
integration. As his Appendix D shows as markets become more integrated market risk premia
normally fall since there is increased diversification and a reduction in risk. This is one of the
most basic results in finance: that diversification lower risk and with it risk premia. It takes
pathologically extreme values to get the market risk premium to increase as markets become
more integrated. This applies to the historic US estimates as well as the Canadian ones:
theoretically they all over-estimate the market risk premium going forward. However, Dr. Booth
makes no adjustments to his market risk premium estimates for the lower risk that results from
better diversified Canadian portfolios.
Dr. Booth prefers to see US market risk premium estimates as simply another set of estimates
from another market and then analyse why they might be similar to Canada. In this regard he
points out that US market risk premium estimates are about 1.0% higher than in Canada split
50:50 with lower bond returns and higher equity returns. Given the role of the US dollar as the
major reserve currency you might expect US equity returns to be about 0.50% higher than US
bond returns or alternatively the Canadian returns to be lower by the same amount. Dr. Booth
would judge the US equity market to be riskier than that of Canada so the higher US market risk
premium makes sense.
This assessment is borne out by Fernandez‟ survey of finance professors worldwide where the
median US finance professor pegs the market risk premium at 6.0% whereas the Canadian one
puts it at 5.1%. Dr. Booth would accept that the market risk premium is most likely between 5.06.0% but recommends 5.0%.
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So Dr. Booth places most weight on Canadian statistics and uses US data as a check. It is not
possible to come up with any simple arithmetic weights.
9.
Reference:
Item C-1-8, ACIG–6, Appendix H, pages 31 and 32, Schedules 1 and 2.
Questions:
9.1
Please provide, from the data available for each company of your samples, the structure of
authorized capital, the authorized returns on an equity base and the bonuses authorized
with the date of decision and the total returns achieved.
9.2
Please provide an analysis of the volatility between the yield authorized and the yield
realized for the companies of your samples.
Answer 9.1 Unfortunately it is not possible to provide all the data since the source of the data
was information requests asked of the different companies at different points in time. As far as
Dr. Booth is aware the TCPL associated companies were not on incentive regulation until 2005
and the class 1 pipes all had 30% common equity ratios until the Mainline successively got this
increased to 33% in 2001 and 36% in 2004 in hearings before the NEB and then 40% in a
settlement with the shippers, the terms of which are confidential. His understanding is that
Foothills (including the BC System) is now also on 36% common equity achieved through
settlement. For the other utilities Enbridge Gas Distribution was on 35% common equity until it
was increased to 36% in 2006, while Union Gas was on 29% until it moved to flow through taxes
and then merged with Centra Gas Ontario and was increased to 35% and then 36% in 2006. In
2005 the BCUC increased Terasen Gas Utility‟s common equity ratio from 33% to 35%.
Answer 9.2 Dr. Booth has done the analysis but does not believe it makes any sense. For
example in the following tables the Mainline Foothills and TQM all have similar variability in the
earned minus allowed of 0.23. However, Foothills had no variation at all until it negotiated an
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incentive deal with the shippers so that for 2005-7 it has significantly over-earned, but this can
not be regarded as risk. Risk is the probability of incurring harm and over-earning is not anyone‟s
definition of harm! Similarly EGDI and Union have high variability since they consistently overearn while TGI has the highest due solely to 1992 when the company was still in its formative
years having been created out of the old Inland Natural Gas the gas assets of BC Hydro.
Mainline Foothills
ANG
TQM
EGDI
UNION
TGI
GMI
0.09
0
0
1.12
0.35
-0.10
0.15
0
0
0.19
0.16
-1.00
0.18
0
0
0.22
0.28
0.70
0.06
0
0
0.25
2.13
1.80
-0.09
0
0
0.3
0.89
0.39
-0.92
0.04
0.31
0
0
0.4
1.01
0.37
0.03
-0.22
0.58
0
0
0.58
1.27
0.77
0.80
0.04
0.48
0
0
0.27
1.50
1.26
1.02
0.4
0.42
0
0
0.11
1.67
0.70
-0.59
0.34
0.06
0
0
0.36
1.26
0.49
1.45
0.58
0.09
0
0
0.06
1.10
0.16
1.25
0.34
0.11
0
-2.75
0.6
0.49
1.50
0.13
0.78
0.42
0
0
0.27
2.15
2.41
0.90
1
0.39
0
-1.58
0.42
3.45
2.13
0.81
0.93
0.27
0
0
0.28
0.97
0.83
0.31
2.02
0.2
0.68
0
0.46
-0.11
0.04
0.65
-0.41
0.11
0.71
0.67
0.43
0.28
0
0.21
0.23
0.75
0.24
0.90
0
0
-3.19
0
0
0.82
0.89
1.28
0.55
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