Electric Utility Stranded Costs: Valuation and Disclosure Issues

We analyze the stock market’s valuation of electric utility “stranded costs” (i.e., costs that might become unrecoverable under deregulation), and investigate whether stranded costs that have arisen as a result of voluntary firm business decisions are valued differently from those that are more directly linked to regulatory mandates. Further, we study whether investor valuations differ across jurisdictions. Finally, we examine the relation between investor valuation of stranded costs and the decision by utilities to make stranded cost‐related disclosures in their financial statements voluntarily. We find that investors anticipate that, on average, approximately 10% of total stranded costs will be borne by utility shareholders. Stranded costs arising from voluntary operating or investing decisions made by utilities are valued more negatively than those associated with mandatory power purchase contracts, consistent with investors assigning a higher recovery probability to the latter. Investor valuations of stranded costs associated with utility generating investments do not differ systematically across jurisdictions. We find that stranded costs are valued less negatively for voluntary disclosers not just in the year of disclosure but also in the preceding two years, implying that it is not disclosure per se that favorably influences valuation. Voluntary disclosers operate in jurisdictions that have more clearly established stranded cost recovery mechanisms, suggesting that both stranded cost disclosure and valuation are prompted by reduction in uncertainty about recoverability.