July 1, 2001
L.A. Loves a Loophole
There's no getting around it...
A Stock-price Premium for DSMA rise in DSM spending (as a percentage of total expenditures) indicated an increase in market-to-book ratio.
For electric utilities, financial and managerial attributes such as rate of return or the dividend payout ratio often exert a strong positive effect on the market-to-book (M/B) ratio (em the ratio of the company's stock price divided by book value. Other factors may carry a negative impact, and these items typically might include the extent of debt financing, nuclear power plant construction, or the percentage of total costs paid in taxes or for fuels.
But what about demand-side management (DSM) programs?
We examined how utility investment in DSM affected M/B ratios, analyzing four years of data collected and made available by the U.S. Energy Information Agency (EIA) for the period 1990-93, which saw the enactment of the Energy Policy Act of 1992, allowing monopoly utilities to own unregulated generating companies and the Federal Energy Regulatory Commission (FERC) to order transmission access (em two developments suggesting that capital markets during that period would have been efficient and would have incorporated the impact of future competition in utility stock market prices. (Nevertheless, the full impact of retail competition may not have been totally felt in the capital markets until the California Blue Book came out in April 1994.)
Importantly, and perhaps surprisingly, our model indicated that investors viewed utilities investing in DSM more favorably than those that did not. Based on the coefficient of a variable defined as "DSM as a Percentage of Total Expenses," our model indicated that a one-percent increase in the share of total expenditures made up by DSM was associated with a 1.9-point increase in M/B ratio.
The graph compares actual M/B ratios over the four-year study period to hypothetical utilities spending 0 percent and 5 percent of total expenditures on DSM.
Of course, DSM expenses may act as a proxy for other variables, such as innovative market strategies or greater levels of customer service. And the fact that DSM expenses may indicate a deferral of new construction might also serve as an explanation for our findings.
In general the market appeared to favor utilities not investing heavily in new construction. That the market put a higher valuation on utilities deferring capital expenditures was also revealed by the parameter estimate of the average plant age. Part of this impact on the M/B ratio is also due to a plant's depreciation lowering a firm's book value. If stock values decrease at a rate lower than asset values due to depreciation, M/B ratios will increase.
Nevertheless, the model appeared to perform very well, with a 64-percent overall explanatory power and statistically significant estimates for most parameters. The parameters estimated in the equation also had the expected signs. The annual intercepts (em YEAR91, YEAR92, and YEAR93 (em captured much of the steady rise that utility stocks experienced over this four-year period.
Other variables with a very significant impact on the M/B ratio included the rate of return and the dividend pay-out ratio, as