Pooling and bypass: Interfirm trade behavior in regulated markets

This dissertation examines the efficiency of interfirm trading behavior in regulated industries. Section I presents a theoretical model of efficient trade mechanisms under uncertainty, and develops a measure of the value of an interfirm trade agreement in the context of sequential 'buy-versus-produce' decision-making by Firms. The theory is applied to estimate the value of a formal trading institution in the California electricity market, where an interutility power pool has been proposed to restructure the electric power industry. I develop an empirical model of the optimal production and trading decisions for a utility in such a pool, and estimate state-contingent willingness-to-trade functions for each of the four major utilities in this market. With this information, I estimate the distribution of future costs that would obtain if an efficient exchange mechanism arbitraged away observed differences between willingness-to-buy and willingness-to-sell among the sample firms. The principal finding is that the gains from trade through a power pool would reduce the firms' production costs by approximately four percent, or {dollar}250 million per year. I conclude with regulatory and managerial explanations for the absence of a more efficient trading mechanism, and implications for deregulating electric power markets.; Section II examines optimal regulatory response to a utility customer considering bypass: service from an alternate, unregulated supplier. I develop a theoretical analysis of how a regulatory agency should respond to a bypass threat if it is concerned with the allocation of the utility's revenues among consumers and uncertain of the potential bypasser's reservation price. Under mild regularity conditions, I derive an explicit bypass policy as a function of the regulator's assessment of the potential bypasser's willingness-to-pay for utility service, and prove the optimality of this policy given the regulator's limited information. This optimal policy involves uniform marginal cost prices but third-degree price-discrimination through fixed charges reflecting the likelihood of bypass. In addition, I demonstrate that even under an optimal policy there is an inefficiently high likelihood of bypass relative to a full-information environment. I address some limitations of current regulatory practice in light of these findings, with particular regard to the telecommunications and electric power industries.