Efficiency in the United States electric industry: Transaction costs, deregulation, and governance structures

Transaction costs economics (TCE) posits that firms have an incentive to bypass the market mechanisms in situations where the cost of using the market is prohibitive. Vertical integration, among other governance mechanisms, can be used to minimize the transactions costs associated with the market mechanism. The study analyses different governance mechanisms, which range from complete vertical integration to the use of market mechanisms, for firms in the US electric sector. This sector has undergone tremendous change in the past decade including the introduction of retail competition in some jurisdictions. As a result of the push toward deregulation of the industry, vertically integration, while still significant in the sector, has steadily been replaced by alternative governance structures. Using a sample of 136 investor-owned electric utilities that reported data the US Federal Energy Regulatory Commission between 1996 and 2002, this study estimates firm level efficiency using Data Envelopment Analysis (DEA) and relates these estimates to governance structure and public policies. The analysis finds that vertical integration is positively related to firm efficiency, although in a non-linear fashion suggesting that hybrid governance structures tend to be associated with lower efficiency scores. In addition, while some evidence is found for negative short-term effects on firm efficiency from the choice to deregulate, this result is sensitive to DEA model choice. Further, competition in retail markets is found to be positively related to firm level efficiency, but the retreat from deregulation, which occurred after 2000, is negatively associated with firm-level efficiency. These results are important in the ongoing academic and public policy debates concerning deregulation of the electric section and indicate that vertical economies remain in the industry, but that competition has provided incentives for improving firm level efficiency.