03-050
COST
REDUCTIONS, COST PADDING AND STOCK MARKET PRICES: THE CHILEAN
EXPERIENCE WITH PRICE CAP REGULATION-050
Rafael Di Tella and Alexander Dyck
We study the Chilean electricity distribution industry and find
that costs (the ratio of reported costs to revenues) have fallen
since price caps were introduced. Cost reductions are U-shaped
since 1989: strong initial cost reductions reverse every four
years, coinciding with regulatory reviews. A possible explanation
is that firms are behaving strategically. We then use stock
market data to complement our study. We construct a measure
of cumulative abnormal returns for regulated firms around their
quarterly announcements, and a measure of “naïve” cost expectations
which excludes any indication of the occurrence of review periods.
In general, cost reports in excess of naïve cost expectations
have a negative effect on returns, even after we control for
company fixed effects. The exception is cost “surprises” that
happen during review periods, which increase abnormal returns.
The estimated effects fall over time. This is consistent with
the hypothesis of strategic firms and that the regulatory regime
translates these “games” into higher rates in a way that is
not completely anticipated by the market. More generally, the
results suggest there may be value in complementing regulatory
procedures with stock market information.
JEL Classification: L43, L50, G14
Keywords: Price-cap regulation, gaming, capture, commitment,
stock market
BGIE
39
pages
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