Using Cost Allocation to Partially Regulate Multi-Market Utilities

This paper derives optimal price structure regulation schemes for partially regulated multi-market utilities, in a context of both complete and asymmetric information. The effects of these regulation schemes on competition and market structure in unregulated segments are explored under oligopoly competition. It is shown that, although Fully Distributed Cost (FDC) can be a good instrument in a partial regulation context with full information, it offers under asymmetric information an opportunity for the multi-market incumbent to engage in strategic accounting manipulation. Multi-market incumbents tend to misreport true marginal costs: costs are inflated in the regulated segment, and competition is harmed in the unregulated segment. The Incremental Cost rule is thus compared to FDC in terms of overall welfare effects, based on the characteristics of this incentive behavior. Accounting manipulation is also studied within antitrust issues, where the anti-competitive effects of possible regulatory failure are highlighted.