The FCC's financial qualification requirements: economic evaluation of a barrier to entry for minority broadcasters.

• Author: Braunstein, Yale M.

1. INTRODUCTION

   In 1965, the Federal Communications Commission ("Commission" or "FCC") articulated certain financial requirements that applicants for broadcast licenses must satisfy. Specifically, applicants had to show they had sufficient funds to cover application costs, construction costs, and the operating expenses for one year without any revenue offsets.(1) This standard, known after the 1965 case as the Ultravision standard, was viewed as implementing the general requirements that "all applications ... shall set forth such facts as the Commission by regulation may prescribe as to the ... financial ... qualifications of the applicant."(2)

   The Commission reduced the operating expense part of the financial qualification to the first three months of operation in a series of decisions in 1978, 1979, and 1981.(3) In announcing these actions, the Commission explicitly cited its concern about the level of minority ownership of broadcasters:

   In announcing this policy change, the Commission considers its action to be one which will provide a more reasonable and realistic financial qualification standard for all aural applicants and will specifically benefit minority applicants seeking entry into the radio broadcast service. The Commission's decision here is based, in large part, on the finding, in its Minority Ownership Task Force Report, that station financing has been a principal barrier to minority broadcast ownership.(4) Additionally, the Ultravision standard conflicts with Commission policies favoring minority ownership and diversity because its stringency may inhibit potential applicants from seeking broadcast licenses.(5) As stated, the underlying rationale is that the financial qualification standard poses a barrier to the entry of new firms into the broadcast market, and this barrier affects, on a disproportionate basis, minority-owned firms which are generally smaller and less well financed than non-minority firms.(6)

   While the specific policies and regulations discussed here date back to the 1980s, the issue of minority ownership remains timely for three reasons: (1) the renewed interest of the Commission in increasing minority ownership of broadcasters,(7) (2) the changes in ownership limits enacted in the Telecommunications Act of 1996,(8) and (3) the planned use of auctions to award new television broadcast licenses,(9) possibly raising new barriers to the entry of minorities.

   This Article focuses on how one might collect and analyze evidence to measure the economic effects of the financial qualification requirements. This Article shall ignore the questions whether these requirements are politically desirable or constitutional, and instead it will focus on economic, not legal, analysis, and examine three major research questions:

   (1) Did the FCC's financial qualification regulations in the 1980s create an unreasonable disadvantage to minorities in the award of new broadcast licenses?

   (2) Can one measure the economic effects on minority broadcasters, on minority employment, and on program suppliers?

   (3) Can one detect any effect on programming and editorial content of these financial requirements?

   The questions this Article addresses are both important and complex. Rarely does one event or policy occur in isolation, so generally one cannot rely on straightforward scientific experiments or quasi-experiments to answer the specific research questions that arise. For example, no one expects the Commission to impose one set of rules on half of the country, while refraining from doing so for the other half, just to facilitate the measurement of the consequences of those rules. Instead, this Article demonstrates a research model and design that, hopefully, enables the detection and measurement of the effects of a specific policy or scenario, as unambiguously as possible and with little confounding.(10)

   This Article will follow a traditional economic approach:

   (1) Present the specific issues in economic terms.

   (2) Develop a logical model that relates various factors to the issues at hand.

   (3) Describe the data necessary to demonstrate how sample analyses of that data might be undertaken.

2. FINANCIAL QUALIFICATION REGULATIONS IN THE 1980S AND UNREASONABLE DISADVANTAGE TO MINORITIES IN THE AWARD OF NEW BROADCAST LICENSES

   1. Background and Economic Logic

      Traditional industrial economics texts have long considered the need for start-up capital to be a significant barrier to the entry of new firms into a market. Douglas Greer, in his 1980 textbook on industrial organization, offers an especially clear statement of this phenomenon:

      In any event, if the capital costs of efficient entry are appreciably more than what you and your friends can scrape together from your savings, say $1 billion, then capital costs pose a barrier to entry--even when MES [minimum efficient scale] plant is small relative to industry demand. This barrier might be classified with the other absolute cost barriers mentioned earlier, since its effect often shows up in higher costs of borrowing, namely, higher interest rates. On the other hand, there are several features of this barrier that distinguish it. For one thing, it is closely connected to scalar elements, whereas other absolute unit cost differences are not. Second, the deterrence of this barrier depends on the nature of the potential entrant as well as on the nature of the industry.(11) There are two conceptualizations of this barrier. First, minority-owned firms (and possibly smaller firms in general), for one or more reasons, have less access to capital markets and traditional lenders. As a result, when they do get start-up financing, the cost of that financing is higher than to other firms. This constitutes the "weak" version of the barrier.

      Second, minority-owned firms simply cannot obtain start-up financing from financial institutions, because the lenders do not make sufficient funds available at any price (interest rate) or because the price is so high as to make the investment unprofitable for the borrower. This constitutes the "strong" version of the barrier.

      The Commission has acknowledged that lack of access to financing creates a barrier to the entry of minority owners in broadcasting.(12) This lack of access to financing may result from discrimination in financial markets, including discrimination by commercial banking institutions, that affects a variety of minority banking customers, of which broadcasters are one type. To put this in context, in 1968, the Commission took the lead in focusing on discriminatory employment practices, stating it would deny licenses to stations that practiced deliberate discrimination.(13) At approximately the same time, in 1974, Congress addressed the issue of discrimination with the Equal Credit Opportunity Act.(14)

      The Commission has addressed the issue of minority access to startup funds through policies such as tax certificates and distress sale regulations. Tax certificates allowed the sellers of broadcast property to postpone the capital gains tax on the proceeds if they sold to a minority-controlled business.(15) The logic behind this policy was that deferring the tax was equivalent to lowering the current effective tax rate, which would increase after-tax profits for the seller. The seller could then pass some of this increased profit on to the buyer in the form of a lower selling price, resulting in a possible reduction of the financial barriers to entry.

      Investors who provided the start-up financing for minority broadcasters could obtain another form of tax certificate when they later sold their interest in the broadcasting entity. The Commission stated, "The use of tax certificates as creative financing tools will facilitate significantly minority entrepreneurs' access to necessary financing, thus effectuating the important policy of promoting minority ownership."(16)

      In its 1995 Notice of Proposed Rulemaking, the Commission summarized its views on tax certificates:

      Exercising the authority conferred upon it by Section 1071 of the Internal Revenue Code, 26 U.S.C. [sections] 1071, the Commission has, since 1978, issued tax certificates to promote minority ownership of broadcast stations. Under the current policy, such tax certificates are awarded to encourage both the sale of facilities to minority purchasers and the investment of start-up capital in minority entities. Thus, tax certificates are available to (1) individuals and entities that sell a broadcast station or cable system to a minority-controlled purchaser and (2) equity holders in a minority-controlled broadcasting or cable entity upon the sale of their equity, provided that their interest assisted in financing the acquisition of a broadcast or cable property or was purchased within the first year after broadcast license issuance, thus contributing to the stabilization of the entity's capital base. In either case, the tax certificate enables the seller to defer for two years the gain realized by (1) treating it as an involuntary conversion, under 26 U.S.C. [sections] 1033, with the recognition of gain avoided by the acquisition of qualified replacement property; or (2) electing to reduce the basis of certain depreciable property, under 26 U.S.C. [sections] 1071, or both.(17) In other words, the intent of the tax certificate program was to lower the effective cost of start-up capital, thereby addressing the weak form of the barrier to entry, and possibly the strong form as well. Congress ended the tax certificate program in 1995.(18) In a recent article, Erwin Krasnow and Lisa Fowlkes propose the reinstatement of the minority tax certificate program.(19)

      The distress sale policy, also adopted in 1978, directly lowered the price of a broadcast property for a minority-owned purchaser. A licensee designated for a license revocation hearing could, for example, before the hearing date, sell its broadcasting property to a minority group for seventy-five percent...