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After Stranding Recovery, What?

Fortnightly Magazine - June 1 1996

will invest overseas (em in plant construction or in distribution systems. The liberalization of communications law will tempt still others into telecommunications and information services that exploit the network properties of their existing assets. Investors should question these notions.

Why should a tradition of monopoly distribution confer the acumen needed to market a commodity? Many manufacturers and service sector firms leave the selling to specialists. In independent power, utilities may in fact have no edge against the contractors that built some of their existing plants. Accustomed to the security of regulation, utilities may be disadvantaged in nations with high political risks. Those that acquire foreign distribution systems may not learn all that much about managing in a deregulated domestic industry. Telecommunications beckons as a new frontier, but electric utilities may not adapt well to a consumer business with a culture of breathless technological change. And, as utility information networks grow, regulators and antitrust authorities may treat them as essential facilities and mandate competitor access.

These pessimistic predictions are not necessarily my personal views, but they are opinions that the capital markets might give utilities seeking funds to enter these new areas. However harsh these judgments, the record shows that investor interest will be better served by the opinions of capital markets than by all but the wisest and luckiest of managements.

Performance-based compensation is relatively rare for utility managers. Some regulators may resist the idea. Nevertheless, to produce shareholder value in today's climate, the compensation awarded utility managers should reward sharper corporate focus and downsizing. It can be done, as when General Dynamics reshaped and shrunk itself to cope with lower defense expenditures. Compensation based on stock performance helped to create $4.5 billion in value for that company's shareholders, while the diversification and growth strategies of its competitors yielded considerably less.6

A Fair Payout

The regulatory compact provides a final reason to pay stranding inflows to investors. If investors deserve recovery because competition confounded their expectations, they alone should receive the cash. They have every reason to return those funds to utility managements whose telecommunications and power marketing proposals look like good investments, and no reason to return the funds to those touting more doubtful projects. Further, utilities that have paid out their recovery will enjoy no funding advantages over their future competitors.

Payout of stranding proceeds also provides a second dimension of fairness: The utilities that stranded the most investment will get the largest windfalls, but not a second chance to invest the money they lost. Fairness holds even where (as most commonly alleged) regulators compelled the construction of plants that management believed harmful to shareholder interests. Such perceptive managers might have an advantage in finding valuable investments after the stranding payoff, and the capital markets will willingly fund such projects. Companies that cannot attract external capital should properly go their way as smaller, wiser, regulated firms. t

Robert J. Michaels is a professor of economics at California State University, Fullerton, consultant in economics and finance with JurEcon, Inc., and adjunct scholar of the Cato Institute. The views expressed in this