Incentives to Quality and Investment: Evidence from Electricity Distribution in Italy

This paper investigates the relationship between output-based incentives for service quality and the use of capital and non-capital resources to meet regulatory targets in the electricity industry. To conduct the empirical analysis we use a dataset collected with the support of the Italian energy regulatory authority, comprising micro data on monetary incentives and physical assets for the largest electricity distribution operator in Italy (86% of the market). Our results show that physical assets and operational expenditures do affect service quality. Moreover, when we investigate causality in the relationship between incentives to quality and the use of capital and non-capital resources, we find that incentives Granger-cause capital expenditures (and not vice-versa). Finally, our results reveal an asymmetric effect of rewards and penalties on capital expenditures’ decisions across areas with different quality levels. From these findings, we derive several policy implications.