Incentives in regulatory DEA models with discretionary outputs: The case of Danish water regulation

Data Envelopment Analysis (DEA) based cost norms are widely used to regulate natural monopolies like water, electricity, and gas networks. In the typical application, demand is considered fixed non-controllable (non-discretionary), challenge incentivize monopoly provide demanded services at lowest possible costs. this paper, we investigate incentives of a DEA regulation when some dimensions, drivers, can, in fact, be controlled by monopoly. such cases, classical may lead suboptimal incentives. Specifically, examine both analytically numerically impacts including discretionary quality indicator benchmarking model Danish water firms. We show that catch-up period allowed gives strong reduce costs since firms can keep reductions for several years before norm fully internalizes reduction potentials. However, on other hand, scheme also provides weak it takes extra increasing internalized norm. • Traditional assumes outputs fixed. choose optimal levels. The longer period, stronger (weaker) these A detailed analysis undertaken.