Effective Regulation of Public Utilities

            My third book, Regulating Mergers and Acquisitions of U.S. Electric Utilities: Industry Concentration and Corporate Complication, will be published by Edward Elgar Publishing in Fall 2020. (Click here for a Summary of Contents.) From February 2020 through March 2021, each monthly essay will excerpt a book chapter. Prior months’ excerpts are available here.

            The March, April and May essays explained the transactions: sales of public franchises for private gain, undisciplined by effective competition, producing a concentrated, complicated industry no one intended.  Repeated 80 times over 30 years, electricity mergers have wasted economic resources, diverted value from customers to shareholders, weakened competitive forces and intensified intra-corporate conflict. Let’s start with economic waste.

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            In both competitive and monopoly markets, acquisition targets choose their acquirers based on highest price. In competitive markets, that highest price will come from the most cost-effective performer. Its ability to compete successfully against others creates the expected revenue-to-cost margin that supports its acquisition price. Competitive markets align the interests of acquirer, target and customers.

            Monopoly markets don’t. Because a monopoly market lacks a competitive market’s discipline, the highest-price acquirer won’t necessarily be the best performer. If target utilities prioritized performance, competing acquirers would lower their offer prices and their costs, enabling post-merger service at lower rates. The economy gains. But target utilities choose their acquirers based on price instead of performance, so the economy loses. As do customers, because their utility has denied them what they pay for: service at a quality and cost that replicates competitive market outcomes.

            But won’t the highest offer price necessarily come from the most cost-effective performer? Not in a utility monopoly market, because the final product price is set not by competition but by regulators. The acquirer will base its high-price offer not on its expectation of beating its competitors but on its expectation of persuading regulators—persuading them to set rates above appropriate levels.

“No harm”: The wrong benefit-cost ratio

            Merger investors seek biggest bang for buck. Most regulators require only “no harm.” This simple difference explains why merger gains go disproportionately to investors. No-harm conflicts with regulation’s central purpose: to produce outcomes comparable to competition. In regulation, “no harm” means zero gain. In competition, zero gain would get any executive fired.