A Normative Analysis of Local Public Utilities: Investments in Water Networks

by Alberto Cavaliere, Mario Maggi and Francesca Stroffolini

We analyze rehabilitation investments in a regulated water industry with perfectly inelastic demand. We compare alternative organizational solutions for local provision (municipalization, corporatization and privatization), though
subject to a common regulatory mechanism. We can then assess the effects of incentive regulation in public firms and find that even benvolent politicians always stick to the price-cap, in order to save on distortionary taxation. How-
ever, incentives to invest result to be excessive only in private firms, as the cost of capital is accounted differently by public and private undertakings.
We also provide a theory of mixed firms, based on strategic interaction between politicians and managers, which contributes to endogenously explain partial privatization and minority participation by private stockholders. In
this last case incentives to invest appear to be driven just by governance and ownership reasons.