Profit-Sharing Regulation: An Economic Appraisal

The stock market, take-over bidders, executive pay setters, perhaps Stephen Littlechild himself, even last summer’s weather, all seem to have been undermining RPI–X price-cap regulation. Until recently, price-cap regulation was regarded as demonstrably superior to US-style rate-of-return regulation, and regulatory reform in several countries has embraced price-cap regulation. But in Britain, where pricecap regulation originated, the case now appears to be less compelling: price-cap regulation is perceived by some as conferring unwarranted profits on the utilities and imposing unsustainable demands on regulators. As a consequence, many people believe that we are slipping inexorably into some form of profit regulation. It is time for reform, say the critics, and the leading candidate to displace RPI–X is `sliding-scale’ regulation, which would share profit gains (and losses) between the regulated firm and its consumers. New Labour has embraced profitsharing regulation, and some of the regulators, notably the Director General of Gas Supply, are interested in it too. In addition, there is a body of academic literature that supports sliding-scale regulation, including the recent papers by Burns, Turvey and Weyman-Jones (1995a and 1995b). Proponents of slidingscale regulation point to four kinds of advantage: allocative efficiency, distributional fairness, risk sharing, and sustainability of regulation.