The paradox of regulatory discretion

• Date: 01 October 2020
• Author: Despoina Mantzari,Francesca Pia Vantaggiato
• DOI: http://doi.org/10.1111/lapo.12158
• Published date: 01 October 2020

REVIEW

The paradox of regulatory discretion

Despoina Mantzari

1

| Francesca Pia Vantaggiato

2

1

Faculty of Laws, University College London,

London, UK

2

Department of Political Economy, King’s

College London, London, UK

Correspondence

Despoina Mantzari, Faculty of Laws,

University College London, London, UK.

Email: d.mantzari@ucl.ac.uk

Abstract

Regulatory authorities in the utilities sector typically

employ economic evidence and analysis to make expert

discretionary judgments under uncertainty. However,

economic analysis does not provide clear answers

regarding policy outcomes. This exposes regulators to

environmental uncertainty, that is, uncertainty regarding

the reactions of other actors in the institutional system

to their decisions. When policy outcome and environ-

mental uncertainty are high, discretion takes center

stage. Will regulators pursue the course of action

suggested by economic analysis and their expert judg-

ment or not? What explains this choice? To answer these

questions, we carry out a comparative analysis of three

British regulatory authorities in the utilities sector: the

Office of Communications, the Office of Gas and Elec-

tricity, and the Water Services Regulation Authority.

We consider two key sectoraland organizational charac-

teristics: the extent of market competition, and statutory

discretion. We rely on interview evidence and documen-

tary analysis and a principal–agent framework. Our

analysis reveals a paradox: when environmentaland pol-

icy outcome uncertainty are high, the higher the regula-

tory discretion, the lower the role of economic expertise

in regulatory decisions. Our findings call for a normative

reflection on the roleof expertise in regulated sectors.

1|INTRODUCTION

Like all bureaucracies, independent regulatory authorities (IRAs) face considerable uncertainty,

both with respect to their environments (Milliken, 1987) and with respect to the consequences

of their decisions (Krause, 2003). In the realm of economic regulation, including in utilities reg-

ulation, the discipline of economics is the cornerstone of regulatory decisions, providing for

DOI: 10.1111/lapo.12158

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

©2020 The Authors. Law & Policy published by University of Denver/Colorado Seminary and Wiley Periodicals LLC.

382 Law & Policy. 2020;42:382–403.wileyonlinelibrary.com/journal/lapo

evidence-based decision making that is meant to reduce uncertainty (O’Toole & Meier, 2003)

and lead to credible and predictable regulatory policy (Majone, 1997). However, economic

analysis is not always capable of reducing uncertainty to acceptable levels. In such cases, the

regulator has a discretionary choice to make: either pursue the course of action that they deem

appropriate, even though its consequences are uncertain, or not pursue it. What explains their

choice? How do utility regulators make discretionary judgments under uncertainty? This article

addresses these questions in comparative perspective, focusing on the use of economic expertise

in three UK IRAs: the Office of Communications (Ofcom),

1

the Office of Gas and Electricity

(Ofgem),

2

and the Water Services Regulation Authority (Ofwat).

3

We rely on evidence derived

from regulatory decisions and court judgments as well as nine semi-structured elite interviews

with regulatory economists working for Ofgem, Ofcom, and Ofwat.

Uncertainty in the regulation of public utilities (Crampes & Laffont, 2016) arises either from

the information asymmetries existing between the regulated entity, who possesses knowledge of

its costs and operations, and the regulator (Laffont & Tirole, 1986), or due to the very nature of

utilities regulation, which is characterized by some as long-term contracting in the context of

uncertainty (Williamson, 1976). To date, however, little attention has been paid to exploring

the use of regulatory discretion when economic analysis does not provide conclusive support to

a regulatory decision. Schrefler (2013) represents a notable exception and suggests that regula-

tors use their expertise differently depending on a given issue’s complexity and the level of con-

flict it triggers in the policy arena. Schrefler (2013) tests her framework on the case of the

British regulator Ofcom by examining several decisions having different levels of conflict and

complexity.

In this paper, we complement and advance Schrefler’s (2013) analysis in three ways. Firstly,

we adopt a comparative approach across regulators of different sectors. Secondly, we narrow

the focus to cases where uncertainty is high, and we redefine policy conflict and complexity as

different types of uncertainty: environmental uncertainty (Milliken, 1987) and policy outcome

uncertainty (Krause, 2003), respectively. Thirdly, we consider sectoral and organizational vari-

ables that predict how regulators will use their expertise in response to uncertainty. With respect

to sectoral variables, we consider the level of retail competition that exists in the markets that

the regulators oversee; with respect to organizational variables, we consider the extent of the

regulators’formal statutory discretion.

To conceptualize the institutional environment of regulatory authorities, we rely on the

principal–agent (P/A) theoretical framework of analysis, which political science has borrowed

from economics (Pollack, 2002; Thatcher & Sweet, 2002). The framework envisages legislators

and/or government as principals, who delegate statutory discretionary powers to bureaucratic

agents (in this case, IRAs) to undertake certain tasks. Therefore, P/A explains the act of delega-

tion. However, P/A theory can also help frame the relationship between principals and agents

postdelegation: regulators/agents have incentives to leverage their expertise to deviate from the

preferences of the principals and further their preferred policy agendas (Weingast &

Moran, 1983); thus, setting boundaries on bureaucratic discretion is one of the most importan t

concerns of agency design (Calvert et al., 1989; Epstein & O’Halloran, 1994). Legislators can

either control agents directly or put in place institutional constraints to tame their discretion

and to flag agency wrongdoing (Epstein & O’Halloran, 1994). These constraints include a third

set of institutional actors, the so-called “ongoing controls”(e.g., regulatees and courts)

(Epstein & O’Halloran, 1994; McCubbins & Schwartz, 1984).

In our analysis, we compare the choices made by IRAs facing high environmental uncer-

tainty and different oversight mechanisms (or “ongoing controls”). We operationalize ongoing

controls with reference to the appeal processes against regulatory decisions. Appeal routes vary

depending on the nature of the issue at hand and also differ significantly for each of the regu-

lated sectors. Furthermore, a number of appeal bodies with dissimilar expertise in regulatory

matters (e.g., the specialist Competition and Markets Authority [CMA], the specialist

LAW & POLICY 383