Introduction
Recall that a basic problem addressed by regulation is an asymmetry between the government and the operator with respect to objectives and information.81
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Chapter I Section H covers information asymmetries. We note elsewhere that there are three basic approaches to dealing with these asymmetries, (a) subjecting the operator to competitive pressures,82 82 [HIDE]
Chapter II examines approaches for competition in the market and competition for the market. Chapter IV covers competition between markets. (b) gathering information on the operator and the market, and (c) applying incentive regulation.83 83 [HIDE]
See Chapter IV for information on incentive regulation. In this chapter we focus on the second of these techniques – gathering information on the operator and the market – with a view towards how this information affects the regulator’s efforts to use incentive regulation.84 84 [HIDE]
Obtaining and managing information is covered in Chapter VII. The immediate chapter examines using financial information. Regulators use incentive regulation primarily to regulate the overall price level of the operator. Financial analysis assists the regulator in this work by providing the regulator with information on how various price levels affect the operator’s ability to obtain capital for investment.
The remainder of this chapter is organized as follows. The paragraphs below describe net present value (NPV) analysis that operators use to make investment decisions and that regulators use (along with other analyses) to value cash flows. Next this narrative discusses financial statements, which are the tools that operators use to record the financial effects of their business decisions. Rules that regulators impose on operators to ensure that the financial statements are useful for regulators are discussed next. This narrative lastly describes how regulators determine whether the operator’s earnings on the regulated operations are sufficient to attract capital for future investments, including techniques for estimating the cost of capital.85 85 [HIDE]
Because financial analysis is central to some of the regulator’s key functions, such as regulating prices, the regulatory processes that the regulator uses when conducting financial analyses affect operator performance and how stakeholders view the regulator. Chapter IV Section 6 and Chapter VIII discuss these regulatory processes. Following this chapter’s narrative is a list of references, organized by topic.
