Balancing information rents and service differentiation in utility regulation

Abstract

In the regulation of natural monopolies such as regional utilities, several goals must be balanced. In this paper, we focus on the trade-off between information rents and service differentiation. Consumers in different regions may prefer different service levels and service mixes. The services provided should therefore ideally be aligned with the preferences of regional consumers. The utilities, however, have superior information about the cost of different services. This allows them to extract information rents by claiming high costs for the provided services. A relative performance evaluation in the form of benchmarking is typically used to limit information rents, but benchmarking is less efficient when service profiles are heterogenous. Hence, there is a trade-off between minimizing information rents and maximizing the adjustment to consumer preferences via service differentiation. In this paper, we study this trade-off in a simple principal–agent model and discuss how it may limit the usefulness of recent regulatory frameworks based on dialog and negotiations with utilities about which services to provide.