Ownership form and rate structure: an examination of cooperative and municipal electric distribution utilities.

• Author: Hollas, Daniel R.

1. Introduction

   There is a substantial body of research which suggests that the structure of property rights incorporated into an organization materially affects the decisions of its managers. Furubotn and Pejovich [8] and DeAlessi [5; 6] provide excellent reviews of the literature on property rights. DeAlessi [2] noted that ownership interests in political firms are virtually non-transferable, which prevents specialization in ownership. This in turn may cause political firm managers to increase their own personal welfare at the expense of the firm. The effect upon not-for-profit firms may be the same since a number of studies that examined the relative economic performance of publicly owned vs. privately owned firms often found significant differences. The Tennessee Valley Authority (TVA) sells wholesale power to two prominent types of presumed not-for-profit, electric distribution firms: municipals (publicly owned) and cooperatives (privately owned). These firms are excellent subjects for the study of how these different property rights affect the rate structures of not-for-profit electric distribution utilities.

   Alchian and Demsetz [1] stated that the owners of a corporation suffer from an attenuation of their property rights due to their reduced control over managers resulting from an inability to easily terminate managers. This problem may be more prevalent in both municipal and cooperative firms than in privately owned profit maximizing firms. They also noted that, in not-for-profit firms, the future consequences of current managerial decisions are not capitalized into the value of the firm. As a result, monitoring and bonding costs are high, and managers of such firms may increase their own personal utility with firm profits. Jensen and Meckling [13] also pointed out that the firm's production function is partially dependent upon the structure of property and contracting rights within which the firm exists.

   One important aspect of the controversy over the effect of ownership form on economic efficiency concerns the pricing (rate setting) behavior of the firm. Peltzman [17] examined pricing behavior in private and municipal electric utilities and hypothesized that prices charged by political (municipal) firms will be biased downward, that prices charged to voters will be lower than to non-voters, and that political firms will forego profitable price discrimination. The effect of ownership form on pricing behavior is further reviewed in DeAlessi [2].

   Stigler and Friedland [20] rejected the hypothesis that regulators will enhance their political popularity by favoring more numerous customers purchasing small quantities of output. DeAlessi [2] took the position that large customers will lobby more effectively. DeAlessi [3] found that publicly owned firms sell wholesale electric power at lower prices and buy it at higher prices than privately owned firms. Meyer [14] found that private (profit maximizing) firms generally charged higher rates than public firms, with the possible exception of rates to large commercial customers. After controlling for regulatory effects, Hollas [10] concluded municipal gas distributors tend to set lower rates for peak customers than do private distributors. Mikesell and Mann [15] examined the pricing behavior of rural electric cooperatives. They concluded that residential and commercial rates are strongly influenced by cost related factors, while non-cost factors influence industrial rates. Eckel [7] examined customer class pricing by utilities and found that a rate-of-return regulated utility has an incentive to distort prices to manipulate demand in predictable ways. Hollas and Stansell [12] analyzed the effects of regulation and ownership form on efficiency of rural electric distribution cooperatives. They concluded that the cooperatives overutilize labor inputs and do not maximize profits. Cooperative firms are privately owned but presumably do not pursue a profit maximization objective. While numerous studies, such as Hollas and Stansell [11], have examined the economic efficiency of power generation firms, few have been performed on electric distribution firms. Neuberg [16] performed one of the first studies of electric distribution firms. Roberts [18] analyzed economies of density and size in the production and distribution of electric power.

   This study examines the rate setting behavior of a set of publicly owned (presumably not-for-profit) municipal utilities and a set of privately owned (presumably not-for-profit) cooperative utilities. Within the literature, we know of no previously published study that contrasts the rate structures of municipal and cooperative electric distribution firms. Therefore, this study makes a contribution because its focus is upon the pricing (rate setting) policies of these two groups of firms. Empirical analysis presented in this paper suggests there is a property rights effect which causes cooperatives to price their output in a more profit oriented manner than do municipals.

2. Pricing In Municipal and Cooperative Enterprises

   A standard treatment of non-profit enterprises is to assume that they maximize welfare. For an enterprise maximizing net social welfare, the objective is to maximize the sum of consumer and producer surplus, that is,

   [Mathematical Expression Omitted],

   where W is net social welfare, [P.sub.ec] is the price per unit sold, [Q.sub.ec] is the quantity of electricity demanded by customer group c, T[C.sub.E] is total operating cost, r is the (constant) market cost of capital, k is the (constant) acquisition cost per unit of capital, and K is a capacity constraint. Assuming that some customers in each group are served during periods of peak demand, users are charged P = MC + rk, that is, their prices must cover marginal operating and capacity costs.

   Technically, TVA distributors are not allowed to make a profit, per se; however, they are expected to build adequate capital reserves (CR) to sustain their operations through negative cash flow periods. Consequently, TVA distributors may have a second objective which is to

   Maximize CR = TR([Q.sub.ec]) - T[C.sub.E]([Q.sub.ec]) - rkK (2)

   subject to [Q.sub.ec] [is less than or equal to] K, c = 1, 2, 3.

   Therefore, a revenue function replaces surplus in the objective function. In the peak period (when MR = MC + rk), the capital reserve-maximizing distributor charges a higher price than does...