In a recent article in the Yale Journal on Regulation,1 two law professors, Aneil Kovvali and Joshua C. Macey, examine the effects of corporate governance of public utilities. Their conclusion: the business model of for-profit, privatized utilities disincentivizes innovation and efficiency as well as cost-savings for consumers, while at the same time, encourages corporate misconduct, such as practices “to curry favor with (or bribe) their regulators” in order to increase regulatory price caps.
The law professors explain that under a for-profit business model, shareholders are the “residual claimants” of the corporation given that they have a claim on whatever money is left over after the corporation has collected revenue from its customers and paid its expenses. By contrast, in a publicly owned utility (such as a municipal water authority), ratepayers are the residual claimants—instead of shareholder profits, the residual value is lower bills for ratepayers and a more efficient utility for the public through reinvestment into it.
The problem arises where the for-profit model is applied to public utilities: because corporately governed utilities focus on shareholder profits, they fail to invest in functional utility systems. The authors explain that “utility shareholders” have “even less incentive than creditors of non-utility firms to take risks, since their legal right to a monopoly means they do not need to innovate to avoid losing market share.” The article further notes that a for-profit utility cannot “boost its profits—at least not significantly—by lowering its costs or innovating,” explaining: “It already has a monopoly, so it will not be able to increase its market share by operating more efficiently or developing higher-quality products.” Regulatory “price caps” in utility industries have a similar effect, according to the authors, “since they prevent shareholders from receiving any value above what the regulator will allow.” This reality not only disincentivizes innovation, efficient operations and cost-savings, but explains the for-profit utilities’ “unusual incentives to curry favor with (or bribe) their regulators” in order to obtain permission from the regulators to increase the rates they charge their customers.
READ THE FULL ARTICLE HERE.
Endnotes:
1 The Yale Journal on Regulation holds itself out as “The Nation’s Top-Ranked Administrative Law and Corporate Law Journal.” See https://www.yalejreg.com/.
