Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2016/4: Finding the Right Yardstick: Regulation under Heterogeneous Environments

Endre Bjørndal (), Mette Bjørndal (), Astrid Cullmann () and Maria Nieswand ()
Additional contact information
Endre Bjørndal: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Mette Bjørndal: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Astrid Cullmann: DIW Berlin, Postal: DIW Berlin, Mohrenstr. 58, 10117 Berlin, Germany
Maria Nieswand: DIW Berlin, Postal: DIW Berlin, Mohrenstr. 58, 10117 Berlin, Germany

Abstract: Revenue cap regulation is often combined with systematic benchmarking to reveal the managerial inefficiencies when regulating natural monopolies. One example is the European energy sector, where benchmarking methods are based on actual cost data, which are influenced by managerial inefficiency as well as operational heterogeneity. This paper demonstrates how a conditional nonparametric method, which allows the comparison of firms operating under heterogeneous technologies, can be used to estimate managerial inefficiency. A dataset of 123 distribution firms in Norway is used to show aggregate and firm-specific effects of conditioning. By comparing the unconditional model to our proposed conditional model and the model presently used by the Norwegian regulator, we see that the use of conditional benchmarking methods in revenue cap regulation may effectively distinguish between managerial inefficiency and operational heterogeneity. This distinction leads first to a decrease in aggregate efficient costs and second to a reallocation effect that affects the relative profitability of firms and relative customer prices, thus providing a fairer basis for setting revenue caps.

Keywords: Data Envelopment Analysis; Yardstick Regulation; Electricity Distribution

JEL-codes: C44; L51; L94

37 pages, February 25, 2016

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