The impact of cost of capital reductions on regulated water utilities in England and Wales: an analysis of isomorphism and stakeholder outcomes

Abstract

This paper investigates the impacts of price cap regulation—weighted average cost of capital reductions determined by The Water Services Regulation Authority (Ofwat)—on the internal actions of regulated water companies in England and Wales through an application of the theory of institutional isomorphism. More specifically, the paper examines the potential impacts of the most recent 2014 PR14 reduction on (1) potential homogeneity of regulated firm behavior and (2) the likely impact on stakeholders, including shareholders, consumers, and employees of regulated water companies. We hypothesize that firms face isomorphic pressures in the wake of WAAC reductions that influence firm behavior regarding financing, investment decisions, profitability and returns to shareholders, service quality and consumer price, and impact on employees and employment levels. The methods utilized include a targeted analysis of available reported water industry annual reports and financial statements and semi-structured interviews with industry professionals. Interview results reveal that companies will utilize debt to fund investment in the future, with a smaller proportion of retained earnings, and that the PR14 reduction would result in downward pressure regarding water companies’ credit ratings. Interviewees stated that the WACC had minimal impact on investment decision-making, but may reduce profitability and returns to shareholders. Regarding service levels and quality, interviewees predict that service levels will remain the same, while consumer prices will decrease or remain the same. Trends towards potential employee reductions were evident through redundancies or the merging of departments.