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A theoretical model of the role of regulatory climate in the capital structure decisions of regulated electric utilities is developed that indicates managers can mitigate the consequences of unfavorable regulation by increasing the proportion of debt in the capital structure. The increase in leverage is limited by increased bankruptcy risk with higher levels of debt. The model predicts that utilities will react to their regulatory climate by adjusting capital structure. This behavior may be an undesirable consequence of the regulatory process. Empirical support for the model, both cross sectional and over time, is provided.

This paper integrates research on the accuracy of alternative long-term earnings forecasts, the gain in accuracy achievable from combining various forecasts, and the power of different long-term earnings forecasts to explain stock prices. The tests are performed on 82 electric utility firms because of the relative homogeneity of accounting data in that industry and because of the importance of the findings for the determination of the cost of capital in a regulatory proceeding. The results are consistent with earlier research findings that analyst forecasts of long-term earnings growth are more accurate than forecasts from extrapolative models. Combined forecasts applied to out-of-sample data, however, did not result in markedly improved forecasting accuracy. Finally, valuation tests of alternative forecasting techniques offered strong evidence that investors place the greatest weight on forecasts from Value Line.