Performance Measurement for Price-Cap Regulation of Telecommunications

Abstract

Price-cap regulation of interstate access charges by the Local Exchange Carriers (LECs), including the Regional Bell Operating Companies (RBOCs), was instituted by the Federal Communications Commission (FCC) in 1991. It replaces rate-of-return regulation in order to secure for the ratepayers some of the benefits of competition in the provision of telecommunications services. An important aspect of the proposed price-cap formula is the productivity growth target (incorporated in the “X factor”) that the LECs must achieve in order to obtain higher rates of return than had been authorized under rate-of-return regulation. The rationale is as follows: during the period that a price-cap formula prevails, the LEC is permitted to keep the profits it realizes beyond full operating costs, and a normal rate of return, provided that its prices conform with the cap. At the end of the period, the price cap is to be adjusted to reflect the recent performance of the LEC. The sharing provision in the price-cap plan assigns a fraction of the excess profits earned by the LEC during the period that a given price cap prevails to its customers in the form of rate reductions. For LECs that elect sufficiently high targets for rate reduction, all excess profits may be retained.

The authors gratefully acknowledge the beneficial effects of comments by Michael Crew, Steven Friedlander, Richard E. Schuler, Jr., and two anonymous referees.