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The Effects of Incentive Regulation on Quality of Service in Electricity Markets

Starting from the late 80s, incentive regulation has replaced rate of return regulation in many states of the U.S. By creating a profit opportunity, the shift to incentive regulation encourages the regulated utility to reduce its costs, which might result in quality cuts. This paper examines the impact of state incentive regulation on two dimensions of quality of service: the average duration and the frequency of electric outages in the electric utility industry of the U.S. between 1993 and 1999. The study is based on a panel data set for 78 major utilities from 23 states of the U.S. It finds that incentive regulation is associated with an increase in the average duration of electric outages, but the implementation of explicit quality benchmarks reduces the average duration of outages per customer. This paper also finds that incentive regulation reduces the utility’s operational and maintenance expenses at the distribution level, which engenders an increase in the duration of electric outages.