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Infrastructure Investment in Network Industries: The Role of Incentive Regulation and Regulatory Independence

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Author Info
Balazs Egert ()

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Abstract

This paper finds that coherent regulatory policies can boost investment in network industries of OECD economies. Rate-of-return regulation is generally thought to result in overinvestment, while incentive regulation is believed to entail underinvestment. Yet, previous empirical work has generally found that the introduction of incentive regulation has not systematically changed investment in network industries. According to the theoretical literature, regulatory uncertainty exposes both types of regimes to the danger of underinvestment. However, regulatory uncertainty is arguably higher under rate-of-return regulation because investment decisions (what can be included in the rate base) are usually evaluated in a discretionary manner, while firms operating under incentive regulation are less affected by this behaviour. In addition, incentive regulation encourages investment in cost-reducing technologies. Using Bayesian model averaging techniques, this paper shows that incentive regulation implemented jointly with an independent sector regulator (indicating lower regulatory uncertainty) has a strong positive impact on investment in network industries. In addition, lower barriers to entry are also found to encourage sectoral investment. These results support the importance of implementing policies in a coherent framework.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 2642.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2642

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Related research
Keywords: network industries; regulation; incentive regulation; price cap; cost-plus regulation; rate-of-return regulation; regulatory independence; investment;

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Find related papers by JEL classification:
L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
L97 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Utilities: General
L98 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Government Policy

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Joskow, Paul L, 1974. "Inflation and Environmental Concern: Structural Change in the Process of Public Utility Price Regulation," Journal of Law & Economics, University of Chicago Press, vol. 17(2), pages 291-327, October.
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  2. David Sappington, 2005. "Regulating Service Quality: A Survey," Journal of Regulatory Economics, Springer, vol. 27(2), pages 123-154, November. [Downloadable!] (restricted)
  3. Dale Lehman & Dennis Weisman, 2000. "The Political Economy of Price Cap Regulation," Review of Industrial Organization, Springer, vol. 16(4), pages 343-356, June. [Downloadable!] (restricted)
  4. Starkie, David, 2006. "Investment incentives and airport regulation," Utilities Policy, Elsevier, vol. 14(4), pages 262-265, December. [Downloadable!] (restricted)
  5. Graeme Guthrie, 2006. "Regulating Infrastructure: The Impact on Risk and Investment," Journal of Economic Literature, American Economic Association, vol. 44(4), pages 925-972, December.
  6. Bradley, Michael & Jarrell, Gregg A & Kim, E Han, 1984. " On the Existence of an Optimal Capital Structure: Theory and Evidence," Journal of Finance, American Finance Association, vol. 39(3), pages 857-78, July. [Downloadable!] (restricted)
  7. Freixas, Xavier & Guesnerie, Roger & Tirole, Jean, 1985. "Planning under Incomplete Information and the Ratchet Effect," Review of Economic Studies, Blackwell Publishing, vol. 52(2), pages 173-91, April. [Downloadable!] (restricted)
  8. Yossef Spiegel & Daniel F. Spulber, 1994. "The Capital Structure of a Regulated Firm," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 424-440, Autumn. [Downloadable!] (restricted)
  9. Mark Armstrong & David E.M. Sappington, 2006. "Regulation, Competition and Liberalization," Journal of Economic Literature, American Economic Association, vol. 44(2), pages 325-366, June.
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  10. Carlo Cambini & Bernardo Bortolotti & Laura Rondi & Yossi Spiegel, 2007. "Capital Structure and Regulation: Does Ownership Matter?," Working Papers 2007.94, Fondazione Eni Enrico Mattei. [Downloadable!]
  11. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
  12. Alberto Alesina & Silvia Ardagna & Giuseppe Nicoletti & Fabio Schiantarelli, 2005. "Regulation And Investment," Journal of the European Economic Association, MIT Press, vol. 3(4), pages 791-825, 06. [Downloadable!] (restricted)
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  13. Greenstein, Shane & McMaster, Susan & Spiller, Pablo T, 1995. "The Effect of Incentive Regulation on Infrastructure Modernization: Local Exchange Companies' Deployment of Digital Technology," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 4(2), pages 187-236, Summer.
  14. Ai, Chunrong & Sappington, David E M, 2002. "The Impact of State Incentive Regulation on the U.S. Telecommunications Industry," Journal of Regulatory Economics, Springer, vol. 22(2), pages 133-59, September. [Downloadable!] (restricted)
  15. Kinnunen, Kaisa, 2006. "Investment incentives: regulation of the Finnish electricity distribution," Energy Policy, Elsevier, vol. 34(7), pages 853-862, May. [Downloadable!] (restricted)
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  1. Stergios Skaperdas, 2009. "The Costs of Organized Violence: A Review of the Evidence," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  2. Axel Dreher & Justina A.V. Fischer, 2009. "Government Decentralization as a Disincentive for Transnational Terror? An Empirical Analysis," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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