Price cap regulation, incentives and quality:: The case of Brazilian telecommunications

This paper reviews the incentive properties of yardstick schemes with special reference to quality performance and to the economic foundations and practical applications of data envelopment analysis (DEA). The core of the paper is related to the construction of synthetic relative efficiency scores for quality, which were obtained for Brazilian local telephony over the period 1998-2002. The telecommunications industry in Brazil has been characterized by the recent implementation of price cap regulation. The evidence indicates substantial quality underperformance, with some improvements towards the end of the period. The efficiency scores obtained, based on the flexible DEA approach, suggest that adjustment factors should be used in the productivity offset of the price cap rule so as to provide premiums for superior quality performance in terms of lower X factors. The DEA-based yardstick procedure can provide a practical alternative to monitoring a series of specific quality indicators in terms of a set of penalties for underperformance. The composite quality indicators do not rule out the identification of optimal adjustments recommended for individual indicators. (C) 2003 Elsevier B.V. All rights reserved.