Tradeoffs in the Power of Regulatory Regimes

Abstract

Abstract Performance-based regulation (PBR) has recently experienced increased popularity in North America and Europe. The genesis for this renewed interest in PBR is the potential to strengthen the regulated firm’s incentives for efficiency relative to traditional rate-of-return regulation. The strength of these incentives is referred to as the power of the regulatory regime (PRR). The PRR depends on the share of the efficiency gains retained by the regulated firm and the length of time that it retains them before being appropriated by the regulator acting as a surrogate for competition. Nonetheless, there are tradeoffs in the design of PBR plans that can render it inferior to traditional earning-based regulation in terms of incentive power. This may explain why the empirical evidence on the performance of PBR is best characterized as “mixed.”