An institutional perspective on assessing real options values in telecommunications cost models

Abstract

Under section 251(c) of the Telecommunications Act of 1996, Congress imposed a duty on incumbent local exchange companies (ILECs) to provide unbundled network elements (UNEs) on a nondiscriminatory basis at just and reasonable rates. This statutory obligation can be viewed as granting an option to competitive local exchange companies to “wait to invest” in their own facilities, but its quantification for inclusion in UNE prices would be controversial. This paper shows that, from an institutional perspective, there is a sound analytical basis for guiding public policy decisions on this issue. More specifically, given the U.S. constitutional framework, which constrains government regulation, the consequences of overestimation as opposed to underestimation of ILECs’ costs are dramatically different. As shown, given the uncertainty of the “true” option value, a regulatory policy based on a cost methodology that tends to overestimate rather than underestimate the option value is more consistent with Congressional policy favoring regulatory intervention that encourages the deployment of an advanced telecommunications infrastructure. Therefore, for purposes of determining prices for UNEs, policymakers should err on the side of overestimating the option value.