Utility ratemaking
Historically, many different classes of business have been classified as public utilities, and thus have been legally mandated to go through the ratemaking process in order to determine the allowable service charges for their industry.
Ratemaking has an economic dimension because it attempts to set prices at efficient (nonmonopolistic, competitive) levels.
Ratemaking is political because the product is determined to be a social necessity and rates must be fair across different classes of consumers.
The above goals attempt to serve the interests of the utility, its shareholders, consumers, and the general public.
Accordingly, because of constitutional takings law, government regulators must assure private companies that a fair revenue is available in order to continue to attract investors and borrow money.
[4] State laws typically restrict utilities from large, sudden rate increases.
Utilities should implement new rates over time so that consumers and business can adapt to the changing prices.
[6] Constraints from regulation have been shown to affect the level of compensation received by executives in electric utilities.
These executives are in charge of large numbers of workers as well as the company's physical and financial assets.
These companies have more political constraints than those in a favorable regulatory environment and are less likely to have a positive response to requests for rate increases.
The need to encourage risk-taking behavior in seeking new investment opportunities while keeping costs under control requires deregulated companies to offer performance-based incentives to their executives.
It has been found that increased compensation is also more likely to attract executives experienced in working in competitive environments.
[9] The Energy Act of 1992 in the United States removed previous barriers to wholesale competition in the electric utility industry.
Currently twenty-four states allow for deregulated electric utilities: Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas, Virginia, Arizona, Arkansas, California, Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Michigan, Montana, New Hampshire, New Jersey, New Mexico, New York, and Washington D.C.[10] As electric utility monopolies have been increasingly broken up into deregulated businesses, executive compensation has risen; particularly incentive compensation.
The determination of value has generally been left to the management of the utility under the theory that these are essentially business decisions which will not be second guessed by a regulatory agency or a court.
Although both agencies and courts have the legal authority to supervise the utility's management, they will not substitute their judgment unless there is an abuse of managerial discretion.
