Allan Ingraham and J. Gregory Sidak study the effects of TELRIC pricing on equity costs for incumbent local exchange carriers

July 1, 2003

In this paper, published in the Summer 2003 issue of the Yale Journal on Regulation, Allan Ingraham and J. Gregory Sidak study the effects of mandatory unbundling at TELRIC prices on incumbent local carriers' equity costs. In particular, Ingraham and Sidak test empirically a hypothesis contained in earlier work published by Thomas Jorde, Gregory Sidak, and David Teece. The Jorde-Sidak-Teece hypothesis states that mandatory unbundling at TELRIC (total element long-run incremental cost) prices would increase the equity costs of incumbent local exchange carriers (ILECs) and reduce their investment incentives by subjecting them to increased risk during economic recession.

Ingraham and Sidak find that the ILECs' betas increased positively and statistically during the recession that began in March 2001. Consequently, their equity costs rose by between 0.4 percentage points and 4.1 percentage points, which reduced their incentives to invest in their own networks. This result is consistent with the Jorde-Sidak-Teece hypothesis.

Recent stock market events also appear consistent with the Jorde-Sidak-Teece hypothesis. On January 6, 2003, a front-page story in the Wall Street Journal speculated that the FCC would revise its rules on mandatory unbundling at TELRIC prices in a manner that would benefit the ILECs. Specifically, the report implied that CLECs would lose the opportunity to lease all network elements as an "unbundled network element platform," better known as UNE-P. The abnormal returns of telecommunications equipment manufacturers on January 6, 2003 are highly probative of whether mandatory unbundling at TELRIC prices - epitomized in its most extreme form by UNE-P - is thought by the capital markets to increase or decrease investment in the network infrastructure required for local telephony. Ingraham and Sidak find that the positive returns for the telecommunications equipment manufacturers exceeded by approximately 5 percent the return that the market could explain. If mandatory unbundling of network elements at TELRIC prices actually encouraged investment in local telecommunications infrastructure, then the abnormal returns to the telecommunications equipment manufacturers would have been negative on January 6, 2003. Instead, the positive abnormal returns to JDS Uniphase, Lucent, Nortel, and Tellabs reflected an expectation of the capital markets that these firms would have increased net cash flows, which would result from greater (not lesser) sales of telecommunications equipment.

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