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in
the
context
of
evolving
and
anticipated
economic,
similar
data
for
the
General
Telephone
&
Electronics
per
share
none
at
all.
Apart
from
these
leverage
considerations, however, the critics also saw what they consid ered
to be significant cost of capital penalties inherent in the company's
traditional financing policies. Debt was seen to be a lower cost
source of funds than equity, as well as a deductible expense for
income tax purposes. Along these lines it was argued that given its
1959 capital base, A. T. & T. could have saved up to $100 million in
taxes and lower capital costs per year for every five percentage
point increase in its debt ratio up to a 45% or 50% level of debt.
The critics also contended that "the highly conservative and
inflexible debt and dividend policies" of the company had led it to
adopt a costly financing strategy during the 1950's as regards the
timing
of
new
capital
issues.
Instead
of
selling
convertible
APPENDIX
CAPITAL STRUCTURE AS RELATED TO RISK AND CREDIT
I. PROBLEM OF APPROPRIATE CAPITAL STRUCTURE
A.
number
of
considerations
are
involved
in
determining
These
basic
risks
are
refl ected
in
the
earnings
factor
in
determining
the
balance
that
is
face
serious
diffi culties
in
periods
of
low
changes
in
Gross
National
Product,
after
than
electric
revenues
but
are
less
utilities,
Bell
System,
and
manufacturing
Comparative
earnings
experience
measured
by
relative
Chart
indicates
that
manufacturing
company
earnings
Similarly
during
the
1937-38
recession,
the
approached
its
long-term
objective.
This
utilities,
with
relatively
stable
earnings,
can
safely
maintain
more
debt
than
b)
0)
a) Because of its greater risks, the Bell System debt ratio must
be lower than the electric utility level.
2.Maintenance of highest credit standing is necessary to obtain
needed capital on most favorable terms.
a) Good credit means not only the ability to raise capital
but also to raise it at reasonable costs.
(1)Almost any business can raise some capital at some
prices.
(2)Real test of good credit is investor evaluation of a com pany's securities compared with high-grade competitive
investment opportunities.
(3)One of the most important factors on which investors
base their evaluation of a company's securities is the
composition of its capital structure.
b) Capital costs vary with the credit of the company, and
investors
(3)
expenses.
2. These developments all tend to make telephone earnings more
vulnerable to unfavorable changes in business conditions and must
be recognized in considering the problem of an appropriate
capital structure.
B. Changes in the market for telephone service are reflected in
changed distribution of telephones among types of users, with
an increase in proportion of those types which tend to be less
permanent (Chart 11, first grid).
1. Residence telephones now about 71% of total telephones in
service, compared with prewar stable average of 60% (Chart 11,
second grid).
a) In the past, residence telephones have been about 48% more
volatile than business telephones, as measured by year-to-year
changes.
b) In business declines, the market for residence telephones falls
further than the market for business telephones.
(1) Residence telephones declined 18% during the depression of
the thirties, while business telephones showed a 12%
decrease.
2. Residence telephone market is now more saturated (Chart 11,
third grid
a) Percentage of households having telephones has more than doubled since 1940, increasing from 37% in 1940 to 78% in 1958.
0) Current higher proportion of subscribing households indicates
that there is included among present customers an even greater
proportion of those who are more likely to discontinue service in
the event of a business decline.
C. Larger proportion of current revenues is derived from more
volatile forms of service.
1. Toll revenues now constitute 37% of the total, compared with
a consistent 3070 average prior to 1940 (..;hart 12, second
grid) -
than
business
calling
during
period
of
general
business recession.
D. Increased rigidity of operating expenses.
1. Brought about by several factors, the most important of which is
payroll expense.
a) Union contracts freeze wage rates, wage progression, and
many personnel practices for the lives of the contracts, thus
making it more difficult for the industry to adjust its
operations quickly to changing economic conditions.
2. Greater rigidity of expenses is particularly significant in view of
the reduced margin of operating income (Chart 12, third grid) .
a) Ratio of net operating income to total revenues now 16%, as
compared with 19% over long period prior to war.
E. Increased risks faced by the Bell System will result in greater
volatility of earnings in the future than has been experienced in
the past.
1. This makes it all the more imperative that the Bell System debt
ratio be kept at its long-term level of approximately one third.