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http://ssrn.com/abstract=658102
 
 

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On the Conceptual Inadequacy of the Original Cost Regulatory System


Michael C. Jensen


Harvard Business School; Social Science Electronic Publishing (SSEP), Inc.; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Fischer Black


Sloan School of Management, MIT

Clifford G. Holderness


Boston College - Department of Finance

1980

Harvard NOM Working Paper

Abstract:     
The original cost regulatory system, as currently used in the regulation of utilities and natural gas pipelines, cannot emulate the response of a competitive firm to high and varying inflation. Although there can be many problems introduced by regulatory lag and by high administrative and hearing costs for all parties, these do not cause the difficulties we are concerned about here. The response of the original cost system to inflation, even when it is applied with no errors or lag, will be non-competitive, socially wasteful, and politically unsatisfactory. The system is conceptually flawed in a fundamental fashion that causes it to breakdown in times of high and varying inflation. It is possible to design a version of original cost regulation that responds appropriately to changes in expected inflation by using changes in interest rates, but such a system still won't deal properly with actual inflation when it differs from expected inflation. To emulate the response of a competitive return to actual inflation, we must use a version of original cost regulation that makes use of changes in a price index rather than changes in market interest rates.

Number of Pages in PDF File: 16

Keywords: regulatory systems, inflation, interest rates, price index, market rate

JEL Classification: A00, H00

working papers series





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Date posted: October 19, 2005  

Suggested Citation

Jensen, Michael C. and Black, Fischer and Holderness, Clifford G., On the Conceptual Inadequacy of the Original Cost Regulatory System (1980). Harvard NOM Working Paper. Available at SSRN: http://ssrn.com/abstract=658102 or http://dx.doi.org/10.2139/ssrn.658102

Contact Information

Michael C. Jensen (Contact Author)
Harvard Business School ( email )
Soldiers Field
Negotiations, Organizations & Markets
Boston, MA 02163
United States
617-510-3363 (Phone)
305-675-3166 (Fax)
HOME PAGE: http://drfd.hbs.edu/fit/public/facultyInfo.do?facInfo=ovr&facId=6484
Social Science Electronic Publishing (SSEP), Inc. ( email )
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United States
617-510-3363 (Phone)
305 675-3166 (Fax)
HOME PAGE: http://ssrn.com/author=9

National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
European Corporate Governance Institute (ECGI) ( email )
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Fischer Black (deceased)
Sloan School of Management, MIT
Author - Deceased
N/A
Clifford G. Holderness
Boston College - Department of Finance ( email )
Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States
617-552-2768 (Phone)
617-277-8071 (Fax)
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