Regulation under Asymmetric Information in Water Utilities

Water utilities are reminiscent of network industries and are characterized by important fixed costs. These factors contribute to a single firm serving an area justifying public intervention on pricing. About one fourth of U.S. water utilities is private and subject to regulation. Regulators are unlikely to be perfectly informed and regulation is unlikely to be costlessly implemented. These inherent imperfections have lead economists to consider the incentive properties of regulatory procedures using the economics of information. See David Baron (1989). The empirical literature on regulation has focused on evaluating the effects of regulation on prices, firms ’ costs, efficiency and innovation in sectors such as airline, electricity and energy as surveyed by Paul Joskow and Nancy Rose (1989). Few of these empirical studies rely on the socalled theory of regulation. Regarding the water industry, there is an abundant literature on residential water demand, firms ’ cost and their efficiency given their public versus private nature. Relying on a model with asymmetric information and a sample of California water utilities, Frank Wolak (1994) assesses the consumer welfare loss due to asymmetric information and shows that the model with asymmetric information provides a superior description of the cost and demand data than the model under perfect