The Evidence for a Small Company Premium on the Cost of Capital at PR09 and A Review of Ofwat's PR09 Draft Determinations on the Small Company Premium: Reports for the UK's Water-Only Companies

01 September 2009
By Dr. Richard Hern, Tomas Haug, Anthony Legg, Mark Robinson, Dominik Huebler, and Svetlana Shcherbakova

A NERA team led by Director Dr. Richard Hern was commissioned by the UK water-only companies (WoCs) to review evidence on the requirement of a small company premium to be included in the regulatory allowed rate of return. NERA's study demonstrated that in order to enable WoCs to maintain access to capital markets on the same terms as the larger water and sewerage companies (WaSCs), a small company premium must be included in the regulatory rate of return allowance. At the previous 2004 price review, Ofwat allowed a small company premium for WoCs depending on companies' size.

NERA provided a comprehensive analysis of the requirement of a small company premium. The project team determined the size of such a premium drawing on quantitative modeling of relative risks using Monte Carlo simulation, analysis of relative illiquidity and transaction costs, and application of multi-factor models such as the Fama-French Three-Factor model. The team also reviewed a range of academic and capital market evidence on the existence of the small company premium.

The NERA team produced a final report on the small company premium for the WoCs in March 2009. Following Ofwat's PR09 Draft Determinations in July 2009, the NERA team subsequently produced a report in September 2009 that reviewed the regulator's draft decision on the small company premium.

Download the March 2009 report.

Download the September 2009 report.