Understanding Railroad Investment Behaviors, Regulatory Processes, and Related Implications for Efficient Industry Oversight

Abstract

Current Surface Transportation Board methods rely on comparisons between revenue needs and the revenues that are earned by railroads. This paper reconsiders the methods that are used to determine this “revenue adequacy”. Specifically, we consider whether the cost of railroad capital might be better estimated through methods that incorporate a “real-options” perspective. While not definitive, our current work suggests that the irreversible nature of many railroad capital expenditures supports a real-options approach and that such an approach could potentially improve assessments of railroad cost of capital. Further, we conclude that applying a real-options methodology also can measurably improve policy-makers’ broader understanding of when, where, and how railroads choose to create new freight capacity.