EXECUTIVE BONUS PROGRAMS AND EFFICIENCY IN ELECTRIC UTILITY REGULATION

The principal hypothesis of this research effort is that improvements in the overall operating efficiency of an electric utility might be induced by the use of an executive bonus system based on fundamental concepts from economic analysis. The concepts that are proposed as the foundation for the executive bonus program include: (1) the separation of ownership and control; (2) the law of diminishing returns; (3) the diminishing marginal utility of income; (4) constrained maximizing behavior; and (5) the long-run considerations of the theory of the firm. Using these concepts and a variation of a total factor productivity index, a prototype executive bonus program is developed for an existing electric utility.;As a general background leading to the emphasis on efficiency incentives for executive management, the economic literature on the allocative efficiency issue in electric utility regulation is critically examined. In addition, the more recent literature on the concepts of X-efficiency and managerial behavior is reviewed. Finally, the current attention given to the management audit by an increasing number of regulatory commissions is criticized for providing a nebulous efficiency incentive for electric utility management.