# The hidden cost of investment: the impact of adjustment costs on firm performance measurement and regulation

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## Abstract

In this study, we address a major problem in the measurement of firm performance and the regulation of natural monopolies, namely the intertemporal character of long-term investment decisions. Specifically, we focus on the impact of adjustment costs of investments on estimates of firms’ technical and cost inefficiency. We make use of a nonparametric dynamic data envelopment analysis to investigate the dynamic inefficiency of electricity distribution and transmission companies in the US during the years 2004–2011. These results are compared to their static counterparts. Our empirical findings reveal that ignoring long-term investments and their corresponding adjustment costs significantly distorts both firm-specific and industrial inefficiency estimates and may thus create misleading incentives for the regulated firms to cut investments.

## Keywords

Dynamic inefficiency Dynamic directional distance function Dynamic data envelopment analysis Electricity transmission and distribution## JEL Classification

D22 D24 D61 D92 L51## Notes

### Acknowledgments

The authors would like to thank Christian Growitsch, Felix Höffler, Alfons Oude Lansink and Spiro Stefanou for helpful comments and suggestions as well as Julia Bellenbaum for excellent research assistance.

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