Output-based incentive regulation in electricity distribution: Evidence from Italy

Incentive regulation in electricity distribution is expected to enlarge its scope, from an input-oriented instrument to one that includes additional, output-based incentives. This creates a potential conflict with more traditional concerns for productive efficiency. In the case of Italy, together with input-oriented instruments, output-based incentives have been applied to indicators of quality for over a decade. Using micro-data from the largest Italian distribution company, we conduct an assessment of the effects of this regulatory framework. The aim of this work is threefold. First, we measure performance in terms of cost-efficiency and find that similar cost-reducing efforts were exercised in all distribution units. Second, we measure performance with respect to the overall regulatory framework. Using quality-related rewards and penalties, we find that more cost-efficient areas were also more successful in earning rewards/avoiding penalties: favorable external conditions have similar, positive effects on both cost and quality performance. Using the cost of the energy not supplied, we find no evidence of a conflict between cost efficiency and social cost efficiency. Results indicate, however, that itis preferable to use social costs when measuring a single unit's performance. From these results we derive specific policy indications.