Incentives, Efficiency and Quality in Regulated Monopolies under Customer Ownership

Richard Meade

No 2015-05, Working Papers from Auckland University of Technology, Department of Economics

Abstract: We extend the theory of monopoly regulation under imperfect information to the case of customer, rather than investor, ownership. The firm's manager can exert two types of effort - a contractible effort to reduce costs, and a non-contractible effort to increase quality. The former decreases expected costs and increases expected profits, while the latter increases expected demand, costs and consumer surplus. We show that the manager faces a conflict between pursuing cost reductions and quality when his or her net marginal disutility of cost-reducing effort is sufficiently increased by quality-enhancing effort. We further show that this conflict can arise even without an effort substitution effect. Thus stronger incentives (i.e. a higher managerial profit share) induce greater cost-reducing effort, but lower quality-enhancing effort. Since customer owners value consumer surplus as well as profits, they optimally provide the manager with weaker incentives than investor owners - who only value profits - for a given regulated price. This implies higher quality but lower efficiency under customer ownership, given price. A customer-owned firm is optimally set a tighter price cap than an investor-owned firm if its profits are less price-sensitive than is relative consumer surplus. This can result in quality differences being reduced between ownership types, but with ambiguous impacts on efficiency differences. Failure to account for ownership-related differences in objective functions gives rise to regulatory distortions.

Keywords: Regulation; Moral Hazard; Cooperatives; Electric Utilities; Gas; Water Utilities; Profit Sharing (search for similar items in EconPapers)
JEL-codes: D82 J33 L51 L94 L95 P13 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2015-05
New Economics Papers: this item is included in nep-ind, nep-pr~, nep-mic and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://www.aut.ac.nz/__data/assets/pdf_file/0013/ ... omics-WP-2015-05.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:aut:wpaper:201505

Access Statistics for this paper

More papers in Working Papers from Auckland University of Technology, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Gail Pacheco ().