Quality Regulation for Monopolistic Electricity Distribution Network Companies: A Theoretical and Experimental Analysis within a Principal-Agent Framework

  • A part of the assets built in the 60s and 70s owned by a typical monopolistic electricity distribution system operator (DSO) in Western Europe is quite old and approaching the wear-out period of their bathtub curves. The resulting increases in asset failure rates lead to higher probability of service interruptions and hence reduce the quality (reliability) level in the entire network. Assuming an ideal welfare-maximizing quality regulation (along with price-based regulation), this should incentivize the profit-maximizing DSO owner to replace these assets before the quality level begins to decline, i.e. to invest at a welfare-maximizing point in time. In such an environment, the DSO owner needs to pass these incentives on to the Chief Executive Officer (CEO) is in charge of investment decision making. This should then allow the DSO owner to undertake the profit-maximizing investments. The DSO owner believes that this transfer of his incentives can be done by a labour contract in line with the industry standard. But will the CEO behave in the interest of the DSO owner regarding profit maximization and replacement investments? This thesis shows by using a theoretical model that the own-expected-total-earnings-maximizing CEO does not behave in the interest of the profit-maximizing DSO owner because he avoids the necessary replacement investments near the end of his labour contract. Therefore, an alternative labour contract that deviates from the industry standard is proposed which encourages the CEO to act in the interest of the DSO owner and in the interest of the overall welfare maximization. Hence, the thesis uses an experiment in order to confirm the theoretical results in practice. Experimental results suggest that not every CEO with idiosyncratic risk preferences behaves according to the theoretical model. This can be explained by the fact that the experiment participants showed different behavioural types, such as indirect reciprocity, conformity, guilt aversion or forward induction, which influenced investment behaviour. In contrast, individual distribution preferences or risk attitudes showed no influence on investment behaviour. Interestingly, no participant in the experiment made the necessary replacement investments near the end of the standard labour contract. Given the stated alternative contract format, 9.5% of the respondents have made necessary investments on time. Therefore, seen from an overall welfare-maximizing perspective the results of the experiment argue to implement the alternative labour contract. A further result, which is based on the experimental data, is that the implementation of the alternative labour contract instead of the standard labour contract is more profitable for the DSO owner, regardless whether the CEO is a risk-neutral own-expected-total-earnings maximizer or a risk-neutral, non-compulsory own-expected-total-earnings maximizer. So, it is sufficient for the regulator to give the DSO owner rather a recommendation than a law or a forcing resolution to implement the alternative labour contract, because it is in the owner’s own (profit-maximizing) interest to offer the alternative rather than the standard labour contract.

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Publishing Institution:IRC-Library, Information Resource Center der Jacobs University Bremen
Granting Institution:Jacobs Univ.
Author:Volker Wannack
Referee:Gert Brunekreeft, Stefan Kettemann, Dennis A. V. Dittrich, Jörg Borrmann
Advisor:Gert Brunekreeft
Persistent Identifier (URN):urn:nbn:de:gbv:579-opus-1002337
Document Type:PhD Thesis
Language:English
Date of Successful Oral Defense:2015/06/16
Year of Completion:2015
Date of First Publication:2015/07/15
Academic Department:Business & Economics
PhD Degree:Economics
Focus Area:Diversity
Library of Congress Classification:H Social Sciences / HF Commerce / HF5001-6182 Business / HF5549-5549.5 Personnel management. Employment management / HF5549.5.I5 Incentives. Incentive awards
Call No:Thesis 2015/22

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