Rationality, accounting and benchmarking water businesses. An analysis of measurement challenges

• Date: 09 April 2018
• DOI: https://doi.org/10.1108/IJPSM-04-2017-0124
• Published date: 09 April 2018
• Pages: 290-315
• Author: Nicholas Pawsey,Jayanath Ananda,Zahirul Hoque
• Subject Matter: Public policy & environmental management,Politics,Public adminstration & management

Rationality, accounting and

benchmarking water businesses

An analysis of measurement challenges

Nicholas Pawsey

School of Accounting and Finance, Charles Sturt University, Albury, Australia

Jayanath Ananda

School of Business and Law, CQUniversity, Melbourne, Australia, and

Zahirul Hoque

Department of Accounting and Data Analytics and

Centre for Public Sector Governance, Accountability and Performance,

La Trobe University, Bundoora, Australia

Abstract

Purpose –The purpose of this paper is to explore the sensitivity of economic efficiency rankings of water

businesses to the choice of alternative physical and accounting capital input measures.

Design/methodology/approach –Data envelopment analysis (DEA) was used to compute efficiency

rankings for government-owned water businesses from the state of Victoria, Australia, over the period 2005/

2006 through 2012/2013. Differences between DEA models when capital inputs were measured using either:

statutory accounting values (historic cost and fair value), physical measures, or regulatory accounting values,

were scrutinised.

Findings –Depending on the choice of capital input, significant variation in efficiency scores and the

ranking of the top (worst) performing firms was observed.

Research limitations/implications –Future research may explore the generalisability of findings to a

wider sample of water utilities globally. Future work can also consider the most reliable treatment of capital

inputs in efficiency analysis.

Practical implications –Regulators should be cautious when using economic efficiency data in

benchmarking exercises. A consistent approach to account for the capital stock is needed in the determination

of price caps and designing incentives for poor performers.

Originality/value –DEA has been widely used to explore the role of ownership structure, firm size and

regulation on water utility efficiency. This is the first study of its kind to explore the sensitivity of DEA to

alternative physical and accounting capital input measures. This research also improves the conventional

performance measurement in water utilities by using a bootstrap procedure to address the deterministic

nature of the DEA approach.

Keywords Australia, Fair value measurement, Data envelopment analysis, Accounting measurement,

Economic efficiency, Urban water utilities

Paper type Research paper

Introduction

New public management (NPM) reforms are designed to enhance the performance,

responsiveness and accountability of public sector agencies through the application of

commercial business practices and the design of incentives packages (e.g. Hood, 1995;

Box et al., 2001; Parker and Gould, 1999; Hoque and Moll, 2001a, b; De Vries and Nemec,

2013; Wiesel and Modell, 2014; Nyland and Pettersen, 2015). A particular focus in recent

times has been the discussion of refinements to public sector service performance reporting

to enable stakeholders to understand how efficiently these entities are deploying resources

to meet their objectives (e.g. Parker and Bean, 2012; Rossi and Aversano, 2015). Reflective of

these NPM concerns and global developments within the water sector (e.g. Abbott and

Cohen, 2009; Marin, 2009), considerable attention has been placed on enhancing the

efficiency of state-controlled Australian water businesses (Cunningham, 2013). This drive

International Journal of Public

Sector Management

Vol. 31 No. 3, 2018

pp. 290-315

© Emerald PublishingLimited

0951-3558

DOI 10.1108/IJPSM-04-2017-0124

Received 18 April 2017

Revised 28 June 2017

Accepted 20 August 2017

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/0951-3558.htm

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for efficiency in the Australian water sector has been hamstrung by many challenges.

Amongst others, these have included a record breaking drought across South-eastern

Australia during 1997-2009 (the “Big Dry”) (e.g. Gergis et al., 2012); escalating infrastructure

and operating costs; a changing population and demographics; coupled with budgetary

constraints and the politicisation of water management (e.g. Bell and Quiggin, 2008; Byrnes,

2013; Marlow et al., 2013; Cooper et al., 2014; Worthington, 2014).

Against this background, data envelopment analysis (DEA) has far reaching

applications in regards to benchmarking the efficiency of water businesses and the

promotion of competition by comparison. DEA is a non-parametric statistical tool that uses

linear programming (LP) to analyse the outputs and inputs of a set of homogeneous

organisations and measure the efficiency of different entities against a best practice frontier

(Worthington, 2000a, b; Davutyan and Kavut, 2005; Glass et al., 2014). The technique has

been widely applied in various public sector settings including, amongst others, local

governments (e.g. De Borger and Kerstens, 1996) and the provision of healthcare (e.g. Ozcan

and Khushalani, 2017) and public transport services (e.g. Daraio et al., 2016). In the specific

case of the water sector, DEA is often used to explore the role of economies of scale and

scope, regulation and ownership structure in influencing efficiency (e.g. Abbott and Cohen,

2009; Guerrini et al. 2010; Worthington, 2014). As such, DEA can support regulators to

design effective policies for water utilities (Walter et al., 2009).

Should DEA or any other efficiency measurement techniques be applied to state-

controlled water businesses and used to measure and benchmark service performance, it is

essential that stakeholders have confidence in the reliability of the resulting efficiency

scores and rankings. In this regard, the choice of input and output variables and the quality

of data is paramount in estimating meaningful relative DEA efficiency and productivity

indices. Unfortunately, given accounting measurement, data availability, and other

challenges, there is still no consensus over the definitions of inputs and outputs used in the

water industry and how they are measured (Abbott et al., 2012). What is more, relatively

little is known about the sensitivity of DEA efficiency scores and firm rankings under

different assumptions (Worthington, 2000a; Berg and Lin, 2008).

Utilising data available for Australian urban water businesses from the state of

Victoria, over the period 2005/2006 through 2012/2013, the focus of this paper is the choice

of capital input for DEA. Capital inputs represent the most significant of all inputs in

monetary terms and they are the most contested in terms of their measurement.

Corresponding with wider NPM trends, Victorian water businesses are now required to

prepare statutory accounts in accordance with IFRS and have recently moved to mark

their statutory in frastructure values to fair va lue (FV). Ut ilising these and other measure s

of the infrastructure, this paper reports the results of a comparison of DEA efficiency

scores, temporal trends, comparative firm rankings, and inter-period consistency when

capital inputs are measured using either: physical information; statutory accounting

historic cost infrastructure values; statutory accounting FV infrastructure values; and

regulatory acco unting infrastructure v alues.

Research focussing on the state of Victoria is of relevance to an international audience

for a number of reasons. Broadly, Australian efforts to reform water management are

often regarded as being at an advanced position by global standards given significant

reforms since the 1990s (e.g. Byrnes et al., 2010; NWC, 2011; Crase et al., 2015). In recent

times, the Victorian government has implemented a number of innovative approaches to

implement a whole-of-water-cycle approach (e.g. Ferguson, et al., 2013; Van Leeuwen, 2017)

and has undertaken a range of large-scale projects to improve the security of supplies

through the construction of a large desalination plant, upgrades to irrigation infrastructure

and the promotion of trade between irrigation and urban water users (e.g. Farrelly and

Brown, 2011).

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