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Financial News

Fortnightly Magazine - March 15 1995

rewarded for creating wealth. The regulatory structure also protects managements from being penalized for failing to pursue shareholder interests. Indeed, regulators feel more comfortable when shareholder interests are not pursued aggressively, since this reduces the political risk of being criticized for allowing utilities to realize an excessively high return.

Utility managements have also been shielded from pressures to produce value for shareholders by the absence of a credible takeover threat. There is little fear of takeovers from nonutility corporations, as a result of the provisions of the Public Utility Holding Company Act (PUHCA). A nonutility that takes over a utility comes under the jurisdiction of PUHCA and is regulated by the Securities and Exchange Commission as a utility holding company. Since nonutilities generally wish to avoid PUHCA involvement, takeovers by nonutilities have never been a material threat to utility managements.

This, of course, does not protect a utility management from a takeover by a group of independent investors. The low stock price that would accompany a management's failure to attend to shareholder interests normally provides a lucrative opportunity for a third party to acquire a large holding of the company's stock. The new investors can then implement policies that serve shareholder interests, which can be expected to raise the stock price to the benefit of the new shareholders.

For utilities, however, there are a number of stumbling blocks. Taking control of a utility will require regulatory approvals. This process is likely to be arduous and time-consuming, and time is of the essence. There is also the possibility that a regulator will render unfavorable rate decisions that prevent the new investors from realizing the benefits they seek for shareholders. A reasonably comfortable working relationship often exists between a utility management and regulators, which reinforces concern over how receptive regulators will be to the new management.

These takeover barriers have been very effective. Electric utilities were immune to the merger and buyout binge of the 1980s and have not been threatened by outside takeovers since the 1930s. Accordingly, utility managements do not have to curry the favor of shareholders to protect themselves against corporate raiders the way other companies do. This and regulators' inherent distrust of shareholder interests insulate utility managements from the pressures that move unregulated companies to create shareholder wealth.

Competition Rewards Shareholders

Unencumbered competition would sweep away the barriers that insulate managements from the pressure to create shareholder wealth. Managements that do not vigorously pursue shareholder interests would be at risk. They would face the same threat from external predators as managements in other industries. If a utility management did not pursue shareholder interests, the financial markets would create effective incentive for a new management to replace the incumbent.

The management-regulatory axis that has traditionally depressed the earned shareholder return would also break down under competition. Earned shareholder returns for utilities would rise to the levels of other industries, leading to an upward valuation of utility stocks. Competition is clearly in the best interests of shareholders. It is also in the public interest. Competition will foster operating efficiencies, provide lower electric