Regulation and Efficiency in the Electric Utility Industry

Abstract

Rate-of-return regulation is a distinct feature of the public utility environment. More than ten years ago, it was argued that this form of regulation might induce utility companies to operate inefficiently. This, the "Averch-Johnson effect, " in spite of being the subject of widespread discussion, has not been assessed through formal quantitative analysis. This paper attempts such an analysis and presents evidence on the existence of the "A-J effect" by investigating a cross section of electric power plants. The Averch-Johnson proposition is strongly confirmed. Estimates of the magnitude of the regulation-induced inefficiency are also provided.