Skip to main content
SpringerLink
Log in

The Impact of Regulation on Utilities’ Investments: A Survey and New Evidence from the Energy Industry

  • Published:
De Economist Aims and scope Submit manuscript

Abstract

Over the last 30 years, regulated sectors have undergone deep reforms in their institutional configuration, tools and goals. This paper reviews the impact of this evolution on energy firms’ investments. First, we survey the existing evidence on the effects of the presence of independent regulatory agencies on utilities’ investment rates in Europe in the MENA countries, and in Latin America, focussing on the role of de facto independence and the institutional framework. Second, we discuss the impact of incentive- versus rate-of-return regulation on firms’ incentives to invest and the interaction with firm private/public ownership. In this regard, we provide new econometric evidence of the recent developments of regulation, using a sample of European energy utilities tracked from 1997 to 2013. Our results confirm previous findings that investment is higher under incentive regulation than under rate of return regulation. However, differently from the earlier results, we find that investments seem to be driven more by the weighted average cost of capital than by the X-factor. The paper concludes reviewing recent evidence on service quality regulation on firm investment specifically on the impact of reward/penalty schemes on capital and operational expenditures.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. Cabral and Riordan (1989), provide theoretical foundation for the fact that investments in cost reducing activities are higher under price cap than under rate of return regulation. Moreover, Biglaiser and Riordan (2000) show that price-cap regulation leads to more efficient capital replacement decisions than RoR regulation, and that investments in cost reduction is more likely to occur in the early years of the regulatory cycle. This is also consistent with the findings of Roques and Savva (2009), i.e. that a more stringent price cap acts as a disincentive for investment. Along the same line, Nagel and Rammerstorfer (2008) show that a restrictive price cap leads firms to reduce investments in cost reduction.

  2. The empirical literature on the impact of price cap on productive efficiency is considerable. For example, Newbery and Pollitt (1997) and Domah and Pollitt (2001) show that UK regional electricity distribution companies increase their productivity and service quality after the introduction of incentive regulation. Estache and Rodriguez-Pardina (1998), Rudnick and Zolezzi (2001) and Pollitt (2004) focus on the impact of incentive regulation on labour productivity of electric distribution companies operating in developing countries. See also the survey by Joskow (2008).

  3. The X-factor enters in the basic formula RPI-X used in price-cap regulation, where the utility’s price is set so as to reflect the overall rate of inflation RPI in the economy, minus the expected efficiency savings X which the utility is expected to achieve. The X-factor induces a decline of prices, hence of revenues in real terms, to account for anticipated technological progress. The price control remains in place for a fixed period during which the firm fully bears its cost.

  4. The MENA region includes Algeria, Djibouti, Egypt, Iran, Iraq, Jordan, Lebanon, Libya, Morocco, Syria, Tunisia, and Yemen.

  5. All firms in the analysis are subject to ex-ante regulation, but some are regulated by an independent agency and some by a ministry or a governmental body.

  6. Empirical evidence of the impact of incentive regulation on investments in other markets besides the energy one has been found by Greenstein et al. (1995) and Ai and Sappington (2002) in the U.S. telecoms; they show that price cap regulation stimulates network modernization, mainly for cost reducing purposes.

  7. In practice, the WACC is not perfectly observable by regulators and must be inferred from the available financial data. Whenever the allowed cost of capital exceeds the actual capital remuneration, the firm may even have incentives to over invest, as for the Averch-Johnson effect.

  8. To assign horizontally integrated firms to either the electricity or the gas industry, we used the largest share of sales revenues.

  9. For one utility, Burgenland Holding, the information about capex is not available.

  10. The data on the adoption of a regulatory scheme are drawn from Cambini and Rondi (2010) and were updated using recent documents released by national regulatory agencies, indicating whether the activity is under incentive regulation (in its different forms, i.e. price cap, revenues cap or firms’ benchmarking) or cost-based (e.g. rate of return) scheme.

  11. Our main findings also hold for the 50% threshold.

  12. Note that the switch from incentive regulation to a hybrid one occurred only after 2009 for electric distributors in Italy. Firms that after 2009 are subjected to hybrid regulation, were previously regulated through incentive mechanisms. As a consequence, the number of firms is the same in models from (3) to (6), but the number of observations increases in column (6).

  13. In our sample, this happened for example in Germany and Italy, while in the other countries the level of X-factor has remained constant over time.

References

  • Abrardi, L., Cambini, C., & Rondi, L. (2016). Investment and regulation in MENA countries: The impact of regulatory independence. In A. Rubino, V. Lenzi, I. Ozturk, & M. T. Costa Campi (Eds.), Regulation and investments in energy markets. Solutions for the Mediterranean (pp. 242–273). Amsterdam: Elsevier.

    Google Scholar 

  • Aghion, P., Algan, Y., Cahuc, P., & Shleifer, A. (2012). Regulation and distrust. Quarterly Journal of Economics, 125(3), 1015–1049.

    Article  Google Scholar 

  • Ai, C., & Sappington, D. E. M. (2002). The impact of state incentive regulation on the U.S. telecommunications industry. Journal of Regulatory Economics, 22(2), 107–132.

    Article  Google Scholar 

  • Alesina, A., Ardagna, S., Nicoletti, G., & Schiantarelli, F. (2005). Regulation and investment. Journal of European Economic Association, 3(4), 791–825.

    Article  Google Scholar 

  • Alesina, A., Ozler, S., Roubini, N., & Swagel, P. (1996). Political instability and economic growth. Journal of Economic Growth, 1(2), 189–211.

    Article  Google Scholar 

  • Andres, L., Foster, V., & Guasch, J. L. (2006). The impact of privatization on the performance of the infrastructure sector: The case of electricity distribution in Latin American countries. World Bank policy research, Working paper 3936.

  • Andres, L., Guasch, J. L., Diop, M., & Lopez, S. (2007). Assessing the governance of electricity regulatory agencies in the Latin American and Caribbean region: A benchmarking analysis. World Bank Policy Research, Working Paper Series, 4380.

  • Andres, L., Guasch, J. L., & Lopez, Azumendi, S. (2008). Regulatory governance and sector performance: Methodology and evaluation for electricity distribution in Latin America. World Bank Policy Research, Working Paper 4494.

  • Armstrong, M., & Sappington, D. (2007). Recent developments in the theory of regulation. In M. Armstrong & R. Porter (Eds.), Handbook of industrial organization (Vol. III). Amsterdam: Elsevier.

    Google Scholar 

  • Armstrong, M., & Sappington, D. E. M. (2006). Regulation, competition and liberalization. Journal of Economic Literature, XLIV, 325–366. June.

    Article  Google Scholar 

  • Averch, H., & Johnson, L. L. (1962). Behavior of the firm under regulatory constraint. American Economic Review, 52, 1059–1069.

    Google Scholar 

  • Biglaiser, G., & Riordan, M. (2000). Dynamics of price regulation. RAND Journal of Economics, 31(4), 744–767.

    Article  Google Scholar 

  • Blank, L., & Mayo, J. W. (2009). Endogenous regulatory constraints and the emergence of hybrid regulation. Review of Industrial Organization, 35, 233–255.

    Article  Google Scholar 

  • Bortolotti, B., Cambini, C., & Rondi, L. (2013). Reluctant regulation. Journal of Comparative Economics, 41(3), 804–828.

    Article  Google Scholar 

  • Cabral, L., & Riordan, M. (1989). Incentives for cost reduction under price cap regulation. Journal of Regulatory Economics, 1, 93–102.

    Article  Google Scholar 

  • Cambini, C., Fumagalli, E., & Rondi, L. (2016). Incentives to quality and investment: Evidence from electricity distribution in Italy. Journal of Regulatory Economics, 49(1), 1–32.

    Article  Google Scholar 

  • Cambini, C., & Rondi, L. (2010). Incentive regulation and investment. Evidence from the European energy utilities. Journal of Regulatory Economics, 38(1), 1–26.

    Article  Google Scholar 

  • Cambini, C., & Rondi, L. (2017). Independent agencies, political interference and firm investment. Evidence from the European Union. Economic Inquiry, 55(1), 281–304.

    Article  Google Scholar 

  • Correa, P., Pereira, C., Mueller, B., & Melo, M. (2006). Regulatory governance in infrastructure industries: Assessment and measurement of Brazilian 193 regulators. Public–private infrastructure advisory facility. Washington, DC: The World Bank.

    Book  Google Scholar 

  • Cubbin, J., & Stern, J. (2006). The impact of regulatory governance and privatization on electricity industry generation capacity in developing economies. The World Bank Economic Review, 20(1), 115–141.

    Article  Google Scholar 

  • Domah, P. D., & Pollitt, M. G. (2001). The restructuring and privatisation of the regional electricity companies in England and Wales: A social cost benefit analysis. Fiscal Studies, 22, 107–146.

    Article  Google Scholar 

  • Ernst, & Young. (2013). Mapping power and utilities regulation in Europe.

  • Estache, A., & Rodriguez-Pardina, M. (1998). Light and lightening at the end of the public tunnel: The reform of the electricity sector in the Southern Cone. World Bank Working Paper.

  • Fazzari, Steven M., Hubbard, R. Glenn, & Petersen, Bruce. (1988). Financing constraints and corporate investment. Brookings Papers on Economic Activity, 1, 141–196.

    Article  Google Scholar 

  • Greenstein, S., McMaster, S., & Spiller, P. (1995). The effect of incentive regulation on infrastructure modernization: Local exchange companies’ deployment of digital technology. Journal of Economics & Management Strategy, 4(2), 187–236.

    Article  Google Scholar 

  • Guthrie, G. (2006). Regulating infrastructure: The impact on risk and investment. Journal of Economic Literature, 44(4), 925–972.

    Article  Google Scholar 

  • Gutiérrez, L. H. (2003). The effect of endogenous regulation on telecommunications expansion and efficiency in Latin America. Journal of Regulatory Economics, 23(3), 257–286.

    Article  Google Scholar 

  • Innovation Electricity Efficiency – IEE (2013) State electric efficiency regulatory frameworks. The Edison Foundation Report, July 2013. Available from: www.edisonfoundation.net/IEE.

  • Joskow, P. L. (2007). Regulation of natural monopolies. In A. M. Polinsky & S. Shavell (Eds.), Handbook of law and economics. Amsterdam: Elsevier.

    Google Scholar 

  • Joskow, P. L. (2008). Incentive regulation and its application to electricity networks. Review of Network Economics, 7(4), 547–560.

    Article  Google Scholar 

  • Knack, S., & Keefer, P. (1997). Does social capital have an economic payoff? A cross-country investigation. Quarterly Journal of Economics, 112(4), 1251–1288.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (1997). Legal determinants of external finance. Journal of Finance, LII(3), 1131–1150.

    Article  Google Scholar 

  • Laffont, J.-J. (1994). The new economics of regulation ten years after. Econometrica, 62(3), 507–537.

    Article  Google Scholar 

  • Laffont, J.-J., & Tirole, J. (2000). A theory of incentives in regulation and procurement. Cambridge, MA: MIT Press.

    Google Scholar 

  • Levi, B., & Spiller, T. (1994). The institutional foundations of regulatory commitment: A comparative analysis of telecommunications regulation. Journal of Law, Economics & Organization, 10(2), 201–246.

    Google Scholar 

  • Littlechild, S. C. (1983). Regulation of British telecommunications profitability. London: HMSO.

    Google Scholar 

  • Lyon, T., & Mayo, J. (2005). Regulatory opportunism and investment behavior: Evidence from the U.S. electric utility industry. Rand Journal of Economics, 36(3), 628–644.

    Google Scholar 

  • Martimort, D. (2006). An agency perspective on the costs and benefits of privatization. Journal of Regulatory Economics, 30(1), 5–44.

    Article  Google Scholar 

  • Nagel, T., & Rammerstorfer, M. (2008). Investment decisions under market concentration and price regulation. Working paper series, Vienna University of Economics and Business Administration. http://ssrn.com/abstract=1009123.

  • Newbery, D., & Pollitt, M. (1997). The restructuring and privatization of Britain’s CEGB—Was it worth it? Journal of Industrial Economics, 45, 269–303.

    Article  Google Scholar 

  • Ofgem. (2010). Handbook for implementing the RIIO model. www.ofgem.gov.uk.

  • Pollitt, M. (2004). Electricity reforms in Argentina: Lessons for developing countries. CMI Working Paper 52, Cambridge Working Papers in Economics. http://www.econ.cam.ac.uk/electricity/publications/wp/ep52.pdf.

  • Reichl, J., Kollmann, A., Tichler, R., & Schneider, F. (2008). The importance of incorporating reliability of supply criteria in a regulatory system of electricity distribution: An empirical analysis for Austria. Energy Policy, 36(10), 3862–3871.

    Article  Google Scholar 

  • Roques, F., & Savva, N. (2009). Investment under uncertainty with price ceilings in oligopolies. Journal of Economic Dynamics & Control, 33, 507–524.

    Article  Google Scholar 

  • Rudnick, H., & Zolezzi, J. (2001). Electric sector deregulation and restructuring in Latin America: Lessons to be learnt and possible ways forward. IEEE Proceedings Generation, Transmission and Distribution, 148, 180–184.

    Article  Google Scholar 

  • Sappington, D. E. M. (2005). Regulating service quality: A survey. Journal of Regulatory Economics, 27(2), 123–154.

    Article  Google Scholar 

  • Sappington, D. E. M., & Stiglitz, J. (1987). Privatization, information and incentives. Journal of Policy Analysis and Management, 6, 567–582.

    Article  Google Scholar 

  • Spiller, Pablo T., & Vogelsang, Ingo. (1997). The institutional foundations of regulatory commitment in the UK: The case of telecommunications. Journal of Institutional and Theoretical Economics, 153(4), 607–629.

    Google Scholar 

  • Ter-Martirosyan, A., & Kwoka, J. (2010). Incentive regulation, service quality, and standards in U.S. electricity distribution. Journal of Regulatory Economics, 38(3), 258–273.

    Article  Google Scholar 

  • Trillas, F., & Montoya, M. A. (2011). Commitment and regulatory independence in practice in Latin American and Caribbean Countries. Competition & Regulation in Network Industries, 12, 27.

    Article  Google Scholar 

  • Volgelsang, I. (2002). Incentive regulation and competition in public utility markets: A 20-year perspective. Journal of Regulatory Economics, 22(1), 5–27.

    Article  Google Scholar 

  • Zhang, Y. F., Parker, D., & Kirkpatrick, C. (2005). Competition, regulation and privatisation of electricity generation in developing countries: Does the sequencing of the reforms matter? The Quarterly Review of Economics and Finance, 45(2–3), 358–379.

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. DIGEP, Politecnico di Torino, Turin, Italy

    Laura Abrardi, Cambini Carlo & Rondi Laura

Authors
  1. Laura Abrardi
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Cambini Carlo
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Rondi Laura
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Cambini Carlo.

Appendix

Appendix

See Table 4.

Table 4 The sample of firms (1997–2013)
Full size table

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Abrardi, L., Carlo, C. & Laura, R. The Impact of Regulation on Utilities’ Investments: A Survey and New Evidence from the Energy Industry. De Economist 166, 41–62 (2018). https://doi.org/10.1007/s10645-017-9310-y

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10645-017-9310-y

Keywords

JEL Classification

Search

Navigation