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Disallowances and overcapitalization in the U.S. electric utility industry

  • Stratford Douglas
  • Thomas A. Garrett
  • Russell M. Rhine

Regulation of an industry often produces unintended consequences. Averch and Johnson (1962) argue that certain regulation of electric utilities provides utilities the incentive to purchase an inefficiently large amount of capital. Another possible and related unintended consequence of electric utility regulation is that regulatory cost disallowances on capital may also increase utilities' incentives to overcapitalize. The authors provide theoretical evidence that capital expenditure disallowances will increase the Averch and Johnson effect in some instances and thus may have contributed to the overcapitalization problem that regulation was designed to discourage. Our model shows that disallowances can reduce the rate of return on investment and thereby increase the Averch and Johnson distortion.

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Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2009)
Issue (Month): Jan ()
Pages: 23-32

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Handle: RePEc:fip:fedlrv:y:2009:i:jan:p:23-32:n:v.91no.1
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  1. Emma Hall & Carol Propper & John Van Reenen, 2008. "Can pay regulation kill? Panel data evidence on the effect of labor markets on hospital performance," LSE Research Online Documents on Economics 3282, London School of Economics and Political Science, LSE Library.
  2. Nemoto, Jiro & Nakanishi, Yasuo & Madono, Seishi, 1993. "Scale Economies and Over-capitalization in Japanese Electric Utilities," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 431-60, May.
  3. Gal-Or, Esther & Spiro, Michael H, 1992. "Regulatory Regimes in the Electric Power Industry: Implications for Capacity," Journal of Regulatory Economics, Springer, vol. 4(3), pages 263-78, September.
  4. Nelson, Randy A., 1985. "Returns to scale from variable and total cost functions : Evidence from the electric power industry," Economics Letters, Elsevier, vol. 18(2-3), pages 271-276.
  5. Supawat Rungsuriyawiboon & Spiro E. Stefanou, 2003. "Dynamic Efficiency Estimation: An Application to US Electric Utilities," CEPA Working Papers Series WP052003, School of Economics, University of Queensland, Australia.
  6. Alfred E. Kahn, 1988. "The Economics of Regulation: Principles and Institutions," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262610523, June.
  7. Jon Nelson, 2003. "Advertising Bans, Monopoly, and Alcohol Demand: Testing for Substitution Effects using State Panel Data," Review of Industrial Organization, Springer, vol. 22(1), pages 1-25, February.
  8. Elizabeth Olmstead Teisberg, 1993. "Capital Investment Strategies under Uncertain Regulation," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 591-604, Winter.
  9. Thomas P. Lyon, 1991. "Regulation with 20-20 Hindsight: "Heads I Win, Tails You Lose"?," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 581-595, Winter.
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