The hidden cost of investment: the impact of adjustment costs on firm performance measurement and regulation

Sebastian Nick and Heike Wetzel

Journal of Regulatory Economics, 2016, vol. 49, issue 1, 33-55

Abstract: In this study, we address a major problem in the measurement of firm performance and the regulation of natural monopolies, namely the intertemporal character of long-term investment decisions. Specifically, we focus on the impact of adjustment costs of investments on estimates of firms’ technical and cost inefficiency. We make use of a nonparametric dynamic data envelopment analysis to investigate the dynamic inefficiency of electricity distribution and transmission companies in the US during the years 2004–2011. These results are compared to their static counterparts. Our empirical findings reveal that ignoring long-term investments and their corresponding adjustment costs significantly distorts both firm-specific and industrial inefficiency estimates and may thus create misleading incentives for the regulated firms to cut investments. Copyright Springer Science+Business Media New York 2016

Keywords: Dynamic inefficiency; Dynamic directional distance function; Dynamic data envelopment analysis; Electricity transmission and distribution; D22; D24; D61; D92; L51 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (6)

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Working Paper: The Hidden Cost of Investment: The Impact of Adjustment Cost on Firm Performance Measurement and Regulation (2014)
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DOI: 10.1007/s11149-015-9285-z

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