Managerial Discretion and Public Utility Regulation

The economics of public utility regulation has ignored the developments in the theory of the firm regarding ownership, control, and managerialism. It is hypothesized that organizational innovations are effective devices for controlling discretion. The multidivisional form of organization provides more control of managerial discretion than does a unitary form. The concept of managerial discretion is important in regulated industries because there is greater opportunity for discretionary expenditures and managerial emoluments. The model used is an expense-preference model of a regulated public utility with managers and stockholders. Further clarification of the interaction between expense preference and regulation is attempted. A comparison of Profit-Maximizing and Expense Preference-Behavior is presented. The results indicate that there are significant behavioral differences between profit maximizing and expense-preference firms regarding rate of return regulation. The analysis indicates that: 1. the overcapitalization effects are still under expense preference, 2. welfare may be higher with expense preference firms, and 3. consideration should be given to regulating certain categories of expense.