Regulatory Price Performance, Excess Cost Indexes and Profitability: How Effective is Price Cap Regulation in the Water Industry?
Aston Business School Working Paper (2009), RP 0920
42 Pages Posted: 22 Mar 2013
Date Written: Septemebr 2009
In this study we apply an index number approach to allow for cross sectional comparisons of relative profitability, productivity and price performance of the regulated Water and Sewerage companies (WaSCs) in England and Wales during the years 1991-2008. In order to better analyse the impact of regulation on WaSC performance, we decompose actual economic profits into spatial multilateral Fisher productivity (TFP), the inverse of which is demonstrated to be a regulatory excess cost index that measures the deviation of a firm’s actual costs from benchmark costs, and a newly developed regulatory total price performance (TPP) index, which measures the excess of regulated revenues relative to benchmark costs. The results indicate that during the years 1991-2000 price caps were "weak" as prices were high enough for the firms to achieve economic profits despite their low productivity levels. However, after 2001 prices became "catch up promoting" as they required less productive companies to eliminate at least some excess costs in order to eliminate economic losses. When compared to alternative methodologies such as DEA and SFA, our index number based approach has the further advantage of allowing meaningful comparative performance measurement even if the number of available observations is extremely limited. We therefore suggest that our approach should be of great interest, not only to those researchers interested in evaluating the effectiveness of regulation, but also to those researchers more focused on developing effective comparative performance techniques, even if sample sizes are limited.
Keywords: profits, productivity, price performance, index numbers, regulation, water industry
JEL Classification: L25, L51, L95
Suggested Citation: Suggested Citation