Regulation, returns and systematic risk: the case of the UK privatised utilities

Abstract

Following the privatisation programme of public utilities implemented by the UK government in the 1980s and early 1990s, an interesting debate on the impact of regulation on the cost of equity capital has emerged. While the effects of regulatory announcements have been studied extensively in the USA, there is very little systematic evidence in the UK. This thesis partly redresses this imbalance by analysing the impact of regulatory announcements on the ex-post returns of equity capital and systematic risk of three utility industries in the UK, namely the electricity, telecommunications and water industries. The main objective of this thesis is to test the impact of regulatory announcements that relate to competition, pricing and the quality of services on the return and risk of equity capital. By using an event-study type methodology, the thesis attempts to isolate the effects of regulation from technical and market uncertainties. The methodology normally used in this type of studies is extended to adjust for the well-documented problem in financial time series of volatility clustering and to allow for changes in the systematic risk through time. Overall, the results in the empirical chapters reveal some important issues. While it is clear from the debate in the literature that the cost of capital influences the choice of regulatory parameters, this thesis provides evidence to support the view that regulation in turn alters the cost of equity capital by affecting the ex-post returns and systematic risk of both individual regulated companies and industries. Although the direction and size of these effects of regulation are not always easy to predict, there is evidence to suggest that they may depend crucially on the structure and competitive posture of the industry, as well as technological and market conditions and the parameters of the regulatory system.