Aude LE LANNIER (ADIS – Paris 11 Orsay)
“Enforcement of Yardstick Contracts & Consistency in Performance Rankings Regulated Water Industry”
Lieu: IAE de Paris
Abstract : Using an unbalanced panel of 22 company observations on both Water and Sewerage companies observed over the period 2002-2008, this study evaluates the consistency of water utility performance rankings for U.K. utilities. For this purpose, the study uses several different stochastic frontier methods (SFA), which allow to distinguish between inefficiency and unobserved heterogeneity that influences the firm’s costs and the different rankings. In order to check the robustness of our results, our empirical strategy is to estimate different models.
The study presents different specifications of stochastic cost frontier models to illustrate which outputs, environmental and quality variables are relevant to measure cost efficiency in the U.K. water and sewerage sector; how quality and control for heterogeneity can be incorporated into benchmarking studies.
The first results show the sensitivity of the stochastic frontier benchmarking methods in our sample. Indeed, the inefficiency scores obtained from different cost frontier models are not found to be robust. The levels of inefficiency estimates as well as the rankings depend on the econometric specification of the model. Actually, the inclusion of quality as an output and variables controlling for heterogeneity (and the specification of error terms) can affect performance rankings. The assumptions retained for the distribution of the error term and for the efficiency evolution over time also affect the ranking. Moreover, the results show that it is necessary to incorporate the quality variables as additional output variables rather than as variables explaining cost inefficiency.
From the policy and regulatory point of view, the lack of robustness of the results suggests that a mechanical use of SFA inefficiency scores results in a price-setting process may be misleading. It could be not recommended to set penalties based on these performances comparisons. Therefore, this issue may explain the fact that companies often try to renege on the yardstick regulatory contract. In a regulatory context, a first conclusion could be that benchmarking results should be used as a starting point for providing information about the range in which the inefficiency scores can be located. A second conclusion could be that regulators may have interest to use a flexible yardstick contract rather than a rigid one, in order to avoid the enforcement costs that are due to recurrent firms-led renegotiation.