Regulation and contracts for utility services: substitutes and complements

Stern, J (2003) Regulation and contracts for utility services: substitutes and complements. Working Paper. London Business School Regulation Initiative Working Paper Series.

Abstract

It is frequently asked that regulation by contract can effectively substitute for regaultion by a specialist regulatory agency for utility service industries. We examine these arguments and consider both legal aspects and the experience of the UK in the nineteenth and early tweentieth century. We consider in detail the UK's problems with reliance on franchise contracts in the railway and electricity industries and in other utility service industries. We conjecture that regulation and contracts are complements for network industries rather than substitutes. The existence of a regulatory agency allows for better and simpler contracts, which are easier to monitor, enforce and revise. This is what would be expected from the theory of incomlete contracts. We demonstrate that UK historical experience is strongly consistent with this view.