During the 1960s–1970s, the heavily regulated U.S. railroad industry was in financial crisis, marked by mass bankruptcies and deteriorating infrastructure from a lack of capital investment. The crisis culminated in the 1970 bankruptcy of Penn Central. Congress concluded that regulation limiting railroads’ ability to adjust shipping rates in response to competition from other modes (e.g., trucking and barges) had contributed to the industry’s inability to earn a sufficient return on investment. This finding shifted the policy objective from protecting shippers against railroads’ potentially excessive shipping rates toward restoring the railroads’ financial health. Congress directed the Interstate Commerce Commission (“ICC”) to develop standards for determining whether railroads earned adequate revenues.
The Staggers Rail Act of 1980 directed the ICC to maintain standards ensuring railroads could earn adequate revenue and to determine annually whether each Class I railroad was Revenue Adequate. Since then, the ICC – and later its successor, the Surface Transportation Board (“STB”) – has issued annual revenue adequacy determinations. A railroad is deemed Revenue Adequate if its Return on Investment (“ROI”) is greater than or equal to its Cost of Capital (“COC”), that is ROI-COC ≥ 0. ICC prescribed the methodology for measuring ROI and COC.
By 2014, the Class I railroads had become consistently Revenue Adequate which raised concerns among shipper groups and led to public hearings before the STB on whether a railroad that had become Revenue Adequate should continue to charge rates higher than those needed to maintain revenue adequacy (STB Ex Parte No. 722). In effect, the question was, “How much excess return is too much?”—that is, by how much should ROI exceed COC?
During the public hearings, on behalf of three Class I railroads, Professor Kevin Murphy— supported by Janice Halpern—and Professor Mark Zmijewski—supported by Pavel Nikolov and Kevin Cuddy—presented analyses addressing that question and proposed modernizing the revenue adequacy determination.