Financial Planning in a Regulated Environment

Recent economic research efforts in rate of return regulation of public utilities have for the most part been couched in a static, steady-state framework, “Averch-Johnson†hypotheses being the most obvious examples [3]. Nevertheless, standard classical microeconomic analysis of rate of return regulation seems to have two important drawbacks: first, it does not address itself to multiperiod relationships; and secondly, it cannot be represented in current-practice financial terms. This paper first outlines rate of return regulation as typically practiced. It then describes the essential features of a model designed to examine intertemporally the financial and capital expansion decision tradeoffs a public utility faces given corporate, institutional, and regulatory constraints. Decision tradeoff questions have assumed substantial policy importance in recent years not only because of the ambiguities in rate of return regulation effects conceptualized in the Averch-Johnson literature but because of the behavioral (occasionally legal) importance of purely financial constraints, such as interest coverage requirements, on corporate investment and financing choices.