Regulatory Opportunism and Investment Behavior: Evidence from the U.S. Electric Utility Industry

Abstract:     
The traditionally large and sunk nature of utility investments gives rise to the possibility, if not the likelihood, of opportunistic behavior on the part of either regulators or regulated firms. In this paper, we develop a theoretical model to provide insights into this possibility, then employ a novel and comprehensive data set to test for the existence and empirical importance of opportunistic behavior in the electric utility industry. Our empirical analysis focuses on the investment consequences of $19 billion in cost disallowances that were levied on electric utilities in the 1980s. The econometric investigation finds evidence of regulatory opportunism for nuclear technology, but not for other technologies. An owner/operator of a nuclear plant under construction scaled back annual investment by $121 million after regulators disallowed other firms in the same state. However, spillover effects were minor for firms building non-nuclear generating units and for firms that owned a share in a nuclear plant under construction but did not plan to operate it. Overall, we find the reduced investment of the late 1980s was due primarily to the existence of excess capacity and a shift away from capital-intensive nuclear technology. Spillover effects from regulatory disallowances may have actually led to a net increase in investment, due to the positive effects on firms building non-nuclear generating units.

Number of Pages in PDF File: 53

JEL Classification: K2, L5, L9

working papers series