Regulatory Restructuring and Incumbent Price Dynamics: The Case of U.S. Local Telephone Markets

Prior to the Telecommunications Act of 1996, many U.S. states restructured their regulatory framework by replacing rate-of-return regulation with competition in both the local exchange service and local long-distance markets and adopting price regulation (price caps and price freezes). Using a panel data set of incumbent firm prices for three services, I investigate whether price regulation and differences in entry conditions affect incumbent operators' rate structures. I find that competition has prompted a significant amount of rate rebalancing by reducing the amount of cross-subsidization present in local telephone markets. In addition, the added flexibility of price cap regulation speeds the rate rebalance effects of competition. © 2004 President and Fellows of Harvard College and the Massachusetts Institute of Technology.