Inside the Black Box: Incentive Regulation and Incentive Channeling on Energy Markets

Abstract

This paper aims to achieve more insight into the complex interplay between the “external” market regulations and “internal” regulations (corporate governance) of energy firms. In recent years, many countries have deregulated the incumbent energy monopolies and have introduced new modes of regulation. However, the new incentive schemes do not represent an unmitigated success story. A major problem seems to be the neoclassical framework that is used for the analysis of energy markets. Therefore, an important goal of this paper is to clarify the boundaries of neoclassical regulation theory. There are two restrictions that hamper the neoclassical analysis of energy markets. The first is the difficulty of overcoming the widely held “black box” view of firms. The second is the idea that agents always make rational choices. The paper proposes a kind of theoretical division of labor for understanding the effectiveness of regulatory schemes in energy markets. Neoclassical economics points out to the sources of market failure, and helps to identify where in particular on the supply chain one is likely to observe natural monopolies. Transaction cost economics explains appropriate governance of vertical relations along the supply chain. And organizational theories can elucidate what happens within firms: their response to regulation, competition, and relations with suppliers. A research agenda for the third component is proposed, drawing on insights from New Sociological Institutionalism and organizational behavior.

Keywords: Energy markets, Regulation theory