Does incentive regulation 'cause' degradation of retail telephone service quality?

Most states in the US have now adopted some variant of incentive regulation for their incumbent local exchange carriers (ILECs), the most common being price cap regulation which constrains annual movements in the prices of intrastate telephone services considered to be non-competitive. Some states have also adopted retail service quality provisions to ensure that ILECs subject to incentive regulation do not pursue cost savings and productivity gains at the expense of service quality. With the impending renewal and revision of incentive regulation plans in several states, there is now an urgent need to understand the nexus between incentive regulation and retail service quality performance. Expanding on past studies of this issue, this paper uses panel data on 49 local exchange carriers for the period 1991-1999 to test for Granger causality from incentive regulation plans to retail service quality performance. Using 12 measures of retail telephone service quality, the primary finding is that average performance has not worsened, and has even improved, as states have moved progressively from rate-of-return regulation for ILECs to various forms of incentive regulation. (C) 2002 Elsevier Science B.V. All rights reserved.