The impact of the rate-of-return constraint on the efficiency of bundled electric service providers

The rate-of-return constraint has been cited as one of the primary reasons regulation fails to encourage economic efficiency since Averch and Johnson authored their seminal article almost 50 years ago. Nevertheless, most empirical research has focused exclusively on the allocative inefficiencies resulting from rate-of-return regulation. More recently, research has addressed how alternatives to rate-of-return regulation affect technical efficiency without explicitly measuring the rate-of-return constraint. By contrast, the study herein examines how the degree of the rate-of-return constraint affects the technical efficiency of bundled electric service providers. The study used data envelopment analysis to quantify the technical efficiency of 60 bundled electric service providers operating under rate-of-return regulation between 2001 and 2003. The study found a positive relationship between the allowed rate of return approved in the last rate case and technical efficiency. The study also found a negative relationship between the use of periodic earnings reviews and technical efficiency.