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Cost Reductions, Cost Padding, and Stock Market Prices: the Chilean Experience with Price-Cap Regulation

Listed author(s):
  • Rafael Di Tella


  • Alexander Dyck


We study the Chilean electricity distribution industry and find that costs (the ratio of reported costs to revenues) have fallen since price caps were introduced. Cost reductions are U-shaped since 1989: Strong initial cost reductions reverse every four years, coinciding with regulatory reviews. A possible explanation is that firms are behaving strategically. We then use stock market data to complement our study. We construct a measure of cumulative abnormal returns for regulated firms around their quarterly announcements, and a measure of "naive" cost expectations which excludes any indication of the occurrence of review periods. In general, cost reports in excess of naive cost expectations have a negative effect on returns, even after we control for company fixed effects. The exception is cost "surprises" that happen during review periods, which increase abnormal returns. The estimated effects fall over time. This is consistent with the hypothesis of strategic firms and that the regulatory regime translates these "games" into higher rates in a way that is not completely anticipated by the market. More generally, the results suggest there may be value in complementing regulatory procedures with stock market information.

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Volume (Year): Volume 8 Number 2 (2008)
Issue (Month): Spring 2008 (January)
Pages: 155-196

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Handle: RePEc:col:000425:008609
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