Measuring the overall cost efficiency of water companies and its determinants: An empirical study of stochastic frontier models

Abstract

Several methodological approaches have been applied to evaluate the performance of water companies for regulatory purposes. Performance assessment involving a long-time period is relevant to consider the heterogeneity of the water companies as many changes might have occurred across years. In this study, we applied three different parametric models to estimate cost efficiency scores for a sample of English and Welsh water companies over the years 1991–2018. Two out of three models employed allowed us to decompose overall cost efficiency (OCE) into persistent and transient cost efficiency, i.e. allow identifying the drivers of OCE. The assessment covered six price reviews, and therefore, OCE estimations were linked with water industry regulation. Results revealed that OCE scores are sensitive to model specification as the average values for models 1, 2 and 3 were 0.959, 0.514 and 0.669, respectively. Nevertheless, the three models converge in identifying the source of raw water as an environmental variable affecting OCE. Cost efficiency estimations evidenced that price reviews conducted in 1999 and 2004 were challenging for water companies as OCE scores decreased. The opposite effect was identified for the subsequent price reviews. Beyond the estimated OCE score for the empirical application carried out, this study highlights the importance of selecting robust and adequate methods to evaluate the performance of water companies considering the main objective of such evaluation.