Regulation and Measuring Cost-Efﬁciency with
Panel Data Models: Application to Electricity
and MASSIMO FILIPPINI
Center for Energy Policy and Economics, Federal Institute of Technology, University of
Lugano, ETH Zentrum, WEC, 8092 Zurich, Switzerland
Department of Economics, University of Lugano, Via Ospedale 13, 6900 Lugano, Switzerland
Abstract. This paper examines the performance of panel data models in measuring cost-
eﬃciency of electricity distribution utilities. Diﬀerent cost frontier models are applied to a
sample of 59 utilities operating in Switzerland from 1988 to 1996. The estimated coeﬃcients
and ineﬃciency scores are compared across diﬀerent speciﬁcations. The results indicate that
while the average ineﬃciency is not sensitive to the econometric speciﬁcation, the eﬃciency
ranking varies signiﬁcantly across models. The reasonably low out-of-sample prediction errors
suggest that panel data models can be used as a prediction instrument in order to narrow the
information gap between the regulator and regulated companies.
Keywords: cost-eﬃciency, electricity utilities, incentive regulation, yardstick competition
Transmission and distribution of electricity have been considered as natural
monopolies, thus less aﬀected by the recent waves of deregulation in power
industry. However, as competition is introduced into generation sector,
regulatory reform and incentive regulation of distribution utilities have
become more common. In traditional cost-of-service regulation systems
companies recover their costs with a risk-free ﬁxed rate of return and
therefore, have little incentive to minimize costs. The incentive-based schemes
on the other hand, are designed to provide incentive for cost-eﬃciency by
compensating the company with its savings. A variety of methods are pro-
posed in the literature. Main categories of incentive-based schemes used for
electricity utilities are: price or revenue cap regulation schemes, sliding-scale
rate of return, partial cost adjustment, menu of contracts, and yardstick
Jamasb and Pollitt (2001) provide an extensive survey of
Author for correspondence: Massimo Filippini, CEPE, ETH Zentrum, CH-8092, Zurich,
Switzerland. Tel: +41-1-632-0649; Fax: +41-1-632-1050; E-mail: ﬁlippini@cepe.mavt.ethz.ch
See Joskow and Schmalensee (1986) for a review of regulation models.
Review of Industrial Organization 25: 1–19, 2004.
Ó 2004 Kluwer Academic Publishers. Printed in the Netherlands.