Regulatory Restructuring and Incumbent Local Exchange Pricing : An Application of a Conditional (S,S) Model to Regulated Price Dynamics

While the Telecommunications Act of 1996 introduces competition into local telephone markets at a national level, prior to the Act many states had already restructured their regulatory methods. In particular, many states allowed for competition in both local service and "local long distance" markets prior to 1996. In addition to the expansion of competition, there has been an increased use of price regulation (price caps and price freezes), rather than traditional cost based regulatory methods in determining and updating rates for local exchange and local long distance toll services. Using a three-dimensional panel data set, I investigate whether price regulation and differences in entry conditions in local exchange and local long distance toll markets have had an impact on rate changes for residential local service, business local service, and local long distance toll service for the incumbent local exchange companies. In doing so, I estimate an empirical model that accounts for the stickiness of rates in regulated industries. The model, based on (S,s) models that have developed in a number of literatures, treats firms as maximizing expected profits in the price adjustment costs and regulatory uncertainty resulting from rate hearings, and regulators as controlling profits in the presence of adjustment costs. I find that competition has prompted a significant amount of rate rebalancing that has reduced the amount of cross-subsidization present in these markets. In addition, the findings suggest that price cap regulation leads to higher rates, relative to rate-of-return regulation