Abstract
Regulation is often thought to discourage innovation. This problem is not evidenced by electric utility behavior up through the mid-1970s, during which time utilities adopted various new generation technologies. However, retrospective “prudence” reviews, common since the 1980s, may discourage utilities from investing in promising but risky new technologies. When innovative technologies have lower expected costs but greater cost variance than conventional technologies, the threat of hindsight review may cause a utility to switch from an innovative technology to a more costly conventional one, and may cause underinvestment. Profit-sharing schemes, properly designed, can promote efficient levels of investment in innovative technologies.
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This paper has benefited from the comments of Kenneth Costello, Tom Grahame, Lorna Greening, Mohammad Harunuzzaman, Douglas Jones, two anonymous referees, and seminar participants at the 1994 meetings of the Transportation and Public Utilities Group of the American Economic Association. Financial support from the U.S. Department of Energy is gratefully acknowledged; the views presented herein, however, are solely those of the author.
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Lyon, T.P. Regulatory hindsight review and innovation by electric utilities. J Regul Econ 7, 233–254 (1995). https://doi.org/10.1007/BF01067096
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DOI: https://doi.org/10.1007/BF01067096