The effect of firm objectives on relative efficiency in the electric utility industry

Abstract

Previous research by economists in the area of regulation has been primarily concerned with the effects of rate of return regulation on the firm's price and output decisions. This has proven to be inadequate in assisting regulators in determining if firm management ought to be responsible for production at minimum cost. The research reported here had as its objective the investigation of firm expenditures and relative firm efficiency. By selecting a regulatory environment which effectively depicts the existing environment, this research has attempted to examine management objectives by investigating the specific expense categories in which over- or underinvestment is likely to occur. The analysis departs from previous research in that it focuses upon those aspects of firm decision making which are effectively within the control of firm management. The research methodology permitted the classification of privately-owned electric utility companies into groups representing different levels of relative efficiency. A composite management objective function was formulated for each of four years investigated. Included in the extracted function were financial and engineering ratios characterizing those areas of firm operation which are critical to a company's relative efficiency classification. The hypothesis that an electric utility company's authorized return represents a mark-up on variable as well as fixed costs involved in the supply of electrical service was supported empirically. It was further concluded that the group of relatively efficient firms has been more successful in maximizing profits and are more concerned on the average with customer service or good will. ...