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The Fortnightly 100 Revisited: Do Utility Stock Prices Reflect Operational Efficiency?

Fortnightly Magazine - February 15 1999

the observed variations in the M/B ratio are explained by the specified relationship.

The results support the hypothesized relationship between market-to-book and the financial ratios in all cases. With the exception of liquidity, these effects are statistically significant in all cases. For example, the positive sign on the coefficient associated with profitability shows that it has a positive effect on market performance and that this effect is statistically significant. In absolute terms, as measured by its "elasticity at the mean," 1 percent increase in profitability ratio would lead to one-tenth of 1 percent change in M/B ratio, on average.

Fuel diversity appears to affect favorably market-to-book ratio, but its contribution is small (elasticity at the mean = 0.007) and surprisingly insignificant from a statistical perspective (t-statistic = 0.23). The binary variable indicating nuclear plant ownership has a negative sign and is statistically significant at a 95 percent level of confidence. This result shows that indeed there is uncertainty among investors concerning the ability to keep these stations running smoothly and economically.

Based on our findings, open access and retail choice are also likely to produce an erosive effect on investor confidence. Further analysis of the relationship between our index of deregulation activity and average M/B ratios at the level of the 10 NERC regions (see Figure 1, M/B Ratio as a Function of Deregulation Activity) indicates a strong negative correlation between the two variables (correlation coefficient = -0.81). It appears that, at least at the aggregate level and in the short run, progress in deregulation of electricity markets is regarded with a certain caution and pessimism among investors.

Productive Efficiency: Why It Matters


In this analysis we set out to explore some of the determinants of market performance in the electric utility industry and, specifically, to measure the unique contributions made by productive efficiency. The "strength" of any of the explored relationships is illustrated by the size of the elasticity measures displayed in the last column of Table 1. Productive efficiency shows the largest elasticity of all the explanatory variables examined in this study. The results show that a 1 percent increase in productive efficiency is likely to lead to more than six-tenths of 1 percent increase in M/B ratio. (Compare that to the impact of "stock ratio," where a 1 percent increase leads to merely 0.017 percent increase in M/B ratio.)

The strong relationship between productive efficiency and market performance as measured by the M/B ratio is apparent in the two-variable scatter plot shown in Figure 2. Judging by the statistical test (t=2.19) of its estimated coefficient, one can also conclude that it is highly improbable that the observed impacts would be attributable to chance.

In the final analysis, it is apparent that productive efficiency matters a great deal. After all, greater efficiency and higher productivity is of paramount importance from the perspective of costs and quality of service. Sub-standard productivity can lead to political (customer relations), regulatory and competitive problems for a utility. But we also have seen that productive efficiency is a broad concept, encompassing myriad operating issues