The Effects of Vertical Separation and Competition: Evidence from US Electric Utility Restructuring

Abstract

Competition increases firm productivity, but in network industries, effective competition requires the vertical separation of firms. Although not necessarily, separation can lead to a trade-off between technical efficiency gains from competition and losses from separation. We use the case of US electric industry restructuring to analyze the combined effect of competition and vertical separation, as well as the individual effects. We analyze the difference-in-difference in inefficient costs between divested units and non-divested units across restructuring or non-restructuring states. We estimate firm-level inefficiency using a non-parametric model of the technology. As the true production technology is unobserved and might differ across firms and time we repeat the analysis for different specifications of the technology. We find that in the worst case the positive competition effect is canceled by a negative separation effect. However, for most models of the technology, the overall effect is positive due to a positive separation effect. We also find that the effects depend on the length of the post-treatment period. Whereas the overall effect is negative right after restructuring it turns positive and grows over time.