Di Tella R., Dyck A., Galetovic A., Hogan W. (2008).

Cost Reductions, Cost Padding, and Stock Market Prices: The Chilean Experience with Price-Cap Regulation. Economia, Vol. 8, No. 2, pp. 155-196.

 

Abstract:

The flaws of traditional rate-of-return regulation are well known. They include a lack of incentives to reduce costs, as well as a tendency for firms to choose the wrong mix of inputs and to misreport costs in order to inflate the revenues allowed by the regulator. Political discretion in imple menting this regulatory regime may further discourage efficient investments by giving firms reason to fear holdup problems after investments are made, particularly when consumer groups are able to capture the regulator. The introduction of price-cap regulation was expected to correct some of these problems. By guaranteeing prices rather than returns and by using long regulatory lags, a price-cap system gives firms the incentive to cut their costs, since they get to keep the residual between prices and costs.