Endogenous Regulatory Constraints and the Emergence of Hybrid Regulation

Models of public utility regulation are often framed, alternatively, as rate-of-return or price-cap regulation. In practice, however, regulators have increasingly adopted a variety of hybrid regulatory constraints that embody elements of both these, and other, regulatory forms. In this paper, we draw upon elements of both the positive economic theory of regulation and standard efficiency-based economic analysis of regulation to develop a model that endogenously yields hybrid regulatory constraints as a regulatory optimum. In this context, the paper further demonstrates that a commonly observed side payment–profit sharing–enhances regulator welfare. The results provide a plausible basis for understanding the pattern of modern regulatory constraints.