Effects of Regulation on Utility Financing: Theory and Evidence

Abstract

standing of these cross-sectional variations might be afforded by the detailed examination of specific industry characteristics and their relationship to firms' financing patterns. The present study offers a methodology for approaching this issue. The first step is to assemble joint theories of industry and financial structure in order to identify the ways in which changing industry conditions might be associated with changes in financing. Evidence on such simultaneous changes can then be examined in an attempt to identify the most plausible joint theory. The methodology is used to investigate the effects of state commission regulation on the financing of electric utilities. This is a natural candidate for study since regulation is such a salient feature of the industry. In addition, the regulatory system imparts some interesting special features to the very nature of utility capital structures. Inherent in all capital structures, for example, are opportunities for shifting wealth between bondholders and shareholders, but under regulation these wealth-shifting opportunities are expanded to encompass consumers as well. Finally, the study of regulation has resulted in several relatively well-specified theories of why regulation is imposed and what its observable effects should be. In Section I, the different theories of capital structure and regulation are discussed and their joint implications are derived. The capital structure theories include the 'perfect capital market' theory, the 'debt capacity' theory and the 'financing hierarchy' theory. The regulatory theories include the 'public interest' or 'market failure' theory, the 'political economy' theory and the 'imperfect monitoring' theory. In Section II, financing data from the early days of state commission utility regulation are used to try to distinguish