CRTP-3

"The Effect of Incentive Regulation on Infrastructure Modernization: Local Exchange 
Companies' Deployment of Digital Technology"

Shane Greenstein, Susan McMaster and Pablo T. Spiller
April 1995

This study examines the investment patterns of all large local exchange telephone 
companies in the United States over time. It identifies how different regulatory 
environments have influenced the recent historical pattern of investment in modern 
infrastructure equipment. It focuses exclusively on the post-divestiture experience 
of local telephone exchange companies (LECs), and examines the growth of fiber 
optic deployment and of complementary equipment associated with the modernization 
of today's information infrastructure. 

Its main findings are as follows: First, price regulation (and in particular price 
caps) is a more potent regulatory mechanism than the standard earnings sharing 
scheme. Second, when associated with an earnings sharing scheme, price regulation 
is less effectie in triggering infrastructure deployment than when it is 
implemented by itself. These results raise questions about the effectiveness of a 
popular regulatory instrument - earnings sharing shcemes - and highlight of 
regulatory policy at both the state and federal level. In particular, given the 
importance being currently placed on the development of the information 
superhighway, regulatory emphasis should be placed more on price regulation than 
on regulating profits.