The market was further unnerved by fears that Hyder, the owner of Welsh Water, may announce a pounds 500m rights issue today alongside the expected halving of its dividend.
Anglian's move added to the general air of investor disenchantment with the industry following the tough price review last week from the water regulator Ian Byatt.
Shares in the company plunged 80p to 520p - a fall of 13 per cent - after the company said it intended paying investors with shares worth 12.8p redeemable next March instead of a conventional cash dividend. Anglian hinted this could become its regular way of making dividend payments. It said it would in future "consider all possible means of maximising the tax efficiency of the group.
The company defended the idea, saying that by paying shareholders in stock rather than cash, which counts as capital and not income, it could avoid adding to its pool of surplus Advanced Corporation Tax, which already stands at pounds 160m.
But the move disadvantages income funds which cannot treat capital as income and would find it more difficult to plan ahead.
One analyst said: "Anglian said this was just an attempt to test the water and guage the market reaction but they seem to have dropped a depth charge." Another accused Anglian of presiding over a "debacle" and failing to explain the rationale behind its dividend proposals adequately.
But Elliott Mannis, Anglian's finance director, maintained the move was in shareholder's interests because it would enable the company to whittle down its unutilised ACT surplus more quickly. He added: "The saying is, `When in a hole stop digging'."
Dealers said the rout in Anglian shares was led by income funds selling down their holdings. But it quickly spread to the rest of the sector which ended the day more than 6 per cent down with particularly heavy falls in Hyder, Pennon, Severn Trent and Thames.
Hyder, which is saddled with pounds 1.6bn of debts and is facing a 10.5 per cent cut in water bills next year, will announce today whether it intends to appeal to the Competition Commission.
In any event it is certain to push through a heavy cut in the dividend and big job losses. Robert Miller-Bakewell of Merrill Lynch is forecasting a cut in the payout for the year of just over 50 per cent, reducing the total dividend to 25p.
Pennon, the owner of South West Water, will also announce job losses today and United Utilities, owner of North West Water will follow suit tomorrow.