Regulatory valuation of public utilities: A case study of the twentieth century

Abstract

This paper analyses the regulatory attitudes to asset valuation in the twentieth century. It focuses in particular on the US experience from Smith v Ames 169 US 466 (1898) to Federal Power Commission v Hope Natural Gas 320 US 591 (1944) and on the experience in the UK in last two decades of the century. It is shown that movements in capital goods prices in the US had a significant impact on regulatory decisions, e.g., regulators were more likely to choose original cost as the regulatory valuation when replacement cost was high. In the UK regulatory agencies moved through valuations increasingly less favourable to the companies from a traditional historic cost model to an ‘original cost’ model based on flotation value. Far from displaying regulatory capture, the evidence is consistent with robust regulation against ‘monopoly’ incumbents.

Keywords::

• public utilities
• regulation
• asset valuation
• privatisation

Acknowledgements

We wish to thank the editor and two anonymous referees for helpful comments.

Notes

^1.Demet and Demet (Legal Aspects of Rate Base and Rate of Return in Public Utility Regulation) point out that ‘in the decision Smyth v Ames the US Supreme Court for the first time seemed to emphasise the necessity of a so called “rate base”’.

^2.Troesken, Regime Change and Corruption, 267.

^3.Hausman and Neufeld, ‘How Politics, Economics and Institutions, 724.

^4.Averch and Johnson, Behavior of the Firm under Regulatory Constraint; Petersen, An empirical test of regulatory effects.

^5.Foreman-Peck and Millward, Public and Private Ownership.

^6.Hannah, Electricity before Nationalisation

^7.Williams, History of the British Gas Industry; ChantlerThe British Gas Industry; Hannah, Electricity before Nationalisation.

^8.Foster, Privatization, Public Ownership.

^9.Singleton, Labour, the Conservatives and nationalisation, 13.

^10.Ashworth, The State in Business.

^11. See Parker, The Official History of Privatisation Volumes I and II, for a detailed discussion of the reasons for privatisation and the development of the regulatory process and Helm, Energy, the State and the Market, for a detailed assessment of privatisation and regulation in the energy sector.

^12. See, for example, Abel, The performance of the state, and Ai and Sappington, The Impact of State Incentive Regulation.

^13.Megginson, The Financial Economics of Privatisation.

^14. The UK unambiguously led the privatisation process amongst the developed countries. Amongst all countries, Chile also has a claim to being a pioneer. However, most of the early Chilean privatisations were not utility companies and, in the 1980s, the Chilean privatisation programme was more akin to that of transition countries.

^15.Hausman and Neufeld, How Politics, Economics and Institutions, 723.

^16. E.g., Grout, Jenkins and Zalewska, Privatisation of Utilities, 927; Grout and Zalewska, On the Undervaluation of Privatized Companies, 215.

^17.Huneke, The Heavy Hand, Ch, VI.

^18. Willcox v Consolidated Gas Co. 212 US 19 (1909).

^19.Montgomery, Judicial Fair Value and the Price Level, 225.

^20. E.g. Bauer, Recent Decisions by the Supreme Court, 254–82; Bauer, Rate Base for Effective, 479–513; HadleyThe Meaning of Valuation, 173–80; Bonbright, Railroad Valuation, 181–205; Bonbright, Major Controversies, 379–89;

^21.St Louis & O'Fallon Railway Co. v United States, 279 US 461 (1929),

^22.Federal Power Commission v. Hope Natural Gas Co. 320 US 591 (1944), 602.

^23.Rose, “The ‘Hope’ Case.”

^24.Phillips, Regulation of Public Utilities, 338.

^25. The relevant sections were Phillips, Regulation of Public Utilities, ch. 8; Digest of US Supreme Court Reports, Vol. 11B, Public Utilities, B18-B25; American Jurisprudence, 138–72.

^26. That is, in the cases where we can categorise the regulatory decision into categories (i) and (ii) there are two cases where we cannot categorise the company's preferred choice but there is no case with a company's preference in category (i) or (ii) where the regulatory judgment is not categorised as (i) or (ii).

^27. Kuznets, Capital in the American Economy.

^28. That is, at time t, I_t =  (C_t/C_t-1+ C_t/C_t-2+….+ C_t/C_t-20) / 20.

^29. The correlation between Reg-choice and Comp-choice is − 29%.

^30. Only four Comp-choice data points are original cost in the data set and all these occur when Reg-choice is replacement cost. Hence, we cannot employ logit once we include Comp-choice in the regression and instead use a linear probability model.

^31. British Telecom Share Prospectus 1984; Dept of Trade and Industry, Licence granted to British Telecommunications; The Water Share Offers Prospectus; Department of the Environment, Instruments of Appointment.

^32.Economic Regulation of Privatised Water Authorities (1986).

^33.Littlechild, Economic Regulation of Privatised Water Authorities, para. 10.21.

^34.Parker, Price Cap Regulation, endnotes 6, 7 and 8.

^35.National Audit Office, The Sale of the Twelve Regional Electricity Companies, Footnote Figure 6.

^36.Parker, Price Cap Regulation, Table 5.

^37. Office of Telecommunications, BT's Cost of Capital.

^38. Office of Telecommunications, Pricing of Telecommunications Services, para 6.45.

^39. Monopolies and Mergers Commission, Gas and British Gas plc, para. 8.11.

^40. Monopolies and Mergers Commission, Gas and British Gas plc, para 7.89.

^41. Whittington, “Current Cost Accounting.”

^42. Monopolies and Mergers Commission, Portsmouth Water plc, 69.

^43. Office of Water Services, Future Charges for Water, 49.

^44. Office of Electricity Regulation, The Distribution Price Control: Proposals.

^45. Office of Electricity Regulation, Ibid., pp 64–9.

^46. Ibid., para 5.65.

^47. See Office of Electricity Regulation, REC Price Controls; and also Offer, Statement on REC Price Controls.

^48. Office of Electricity Regulation, The Distribution Price Control: Revised Proposals.

^49. Ibid., 13–19. See Helm, Energy, the State and the Market, 208–11, for discussion of the background to the review.

^50.Office of the Rail Regulator, The Periodic Review of Railtrack's Access Charges, 47–8 and 59–62.

^51. However, market value at flotation is only one notion of original cost at flotation day.

^52. Note, however, that these studies in specific industries after World War II when such assessments were easier to make because the regulatory models were more standardised.

^53. Eiteman (1962).

^54. Stuart (1962)

^55. Petersen (1976)

^56. Garside, Grout, and Zalewska, “Does Experience Make You ‘Tougher’?”

^57. Kuznets, Capital in the American Economy, Tables R4, R5, R22, R23.

Additional information

Notes on contributors

Paul A. Grout

Paul A. Grout is Professor of Political Economy at the University of Bristol (UK) and a non-executive director of the Office of Gas and Electricity Markets (Ofgem).

Andrew Jenkins

Andrew Jenkins is a Research Fellow in the Department of Quantitative Social Science at the Institute of Education, University of London (UK).

Anna Zalewska

Anna Zalewska is Professor of Finance, School of Management, University of Bath and Director of the Centre for Governance and Regulation, University of Bath (UK).