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 inv estigate whether stranded costs that have arisen as a result of voluntary f irm business decisions are valued differently from those that are more dire ctly linked to regulatory mandates, Further, we study whether investor valu ations differ across jurisdictions. Finally, we examine the relation betwee n investor valuation of stranded costs and the decision by utilities to mak e stranded cost-related disclosures in their financial statements voluntari ly. We find that investors anticipate that, on average, approximately 10% of to tal stranded costs will be borne by utility shareholders. Stranded costs ar ising 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 probabili ty to the latter. Investor valuations of stranded costs associated with uti lity generating investments do not differ systematically across jurisdictio ns. We find that stranded costs are valued less negatively for voluntary di sclosers not just in the year of disclosure but also in the preceding two y ears, implying that it is not disclosure per se that favorably influences v aluation. Voluntary disclosers operate in jurisdictions that have more clea rly established stranded cost recovery mechanisms, suggesting that both str anded cost disclosure and valuation are prompted by reduction in uncertaint y about recoverability.