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Implementing incentive regulation with bounded regulators

May 2012

This work was presented to the FSR annual conference in May 2011, the TU Berlin infrastructure conference in October 2011, the FSR executive seminar in January 2012, the ESNIE workshop in May 2012, the ISNIE annual conference in June 2012 and the FSR infrastructure workshop in June 2012.

It is puzzling today to explain the diversity and imperfection of regulation applied to network monopolies. We argue that two sets of fundamental characteristics should be deemed when searching for the most appropriate regulatory tools to implement.

First, the bounded endowment of regulators set by the governments and the legislators determines their abilities (staff, budget, judicial powers) to implement any of the regulatory tools. Ranging these tools from the easiest to the most complex to implement, they are: a- cost plus, b- price/revenue cap, c- output regulation, d- yardstick competition or e- menu of contracts. Besides, the regulator must take into account that the network monopolies perform multiple tasks with heterogeneous regulatory characteristics in terms of controllability, predictability and observability. These tasks characteristics determine what type of regulatory tool is more likely to better regulate each network monopoly’s tasks. In general, incentive schemes should be implemented with tasks responding well to the criteria of controllability and predictability. It is then the level of observability of these tasks which should set the particular incentive tool to implement.

Conclusions for the regulation of network monopolies’ tasks are then derived from the actual regulatory capability of regulators.

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