THE SCALE AND PATTERNS OF ABNORMAL RETURNS TO EQUITY INVESTMENT IN THE UK WATER Industry

THE SCALE AND PATTERNS OF ABNORMAL RETURNS TO EQUITY INVESTMENT IN THE UK WATER Industry

Roger Buckland

Patricia Fraser*

Department of Accountancy, University of Aberdeen, Edward Wright Building, Dunbar Street, Aberdeen AB24 3QY, Scotland

Abstract

This paper explores the scale and behaviour of abnormal returns in the equities of the Water and Sewerage Companies (WASCs) formed at privatisation of the UK water industry in 1989. WASCs are regulated by price caps, intended to deliver efficiency gains to consumers while preserving incentives for shareholders and management to generate greater efficiencies. The regulator's assessment of the riskiness of and appropriate level of return on investment in the industry is critical in determining household bills for water services, in establishing financially robust organisations to deliver services and in rewarding investors for their purchase of financial assets. The paper uses the CAPM and employs techniques of the Kalman Filter to generate estimates of time-variation in abnormal returns (alpha coefficients) and in systematic risk (beta coefficients). It demonstrates that there is substantial time variation to both abnormal returns and risk; and that there is strong evidence of regulatory and political impacts upon returns. The paper confirms that significant excess returns have been generated over the history of the privatized water sector in the UK. It suggests that over-estimation of the systematic risk faced by investors in the sector may imply further substantial excess returns in the next regulatory review period.

Acknowledgement

The authors are Professor of Accountancy and AAM Professor of Finance and Investment Management, Department of Accountancy, University of Aberdeen, Edward Wright Building, Dunbar Street, Aberdeen AB24 3QY, Scotland. The authors acknowledge with thanks the support of the Economic and Social Research Council, who supported the research reported here through their grant L114251027 The Interaction of Accounting Frameworks and Outcomes in Regulated Utilities, in phase 2 of the Contracts and Competition programme; principal researchers Roger Buckland, Dr Lydia Thomson, University of Aberdeen. The insights and inputs of regulators and utilities' managers interviewed in that project and the comments of colleagues in the Department and elsewhere have been gratefully received.

Address for correspondence: Roger Buckland, tel. (+44) (0)1224 272206, email r.buckland@abdn.ac.uk