Efficiency and the Hold-up Problem in Regulated Industries: Empirical Evidence on the Natural Gas Transport Industry

Abstract: In 2002, Argentinean companies of natural gas transportation had to endure a breach of contract. After a serious devaluation of the domestic currency, the government decided to freeze transmission rates. Despite high inflation rates, this disruptive policy lasted more than a decade. That rate-freezing mechanism could be interpreted as a contractual problem known as hold-up, which in turn affects many economic aspects such as investment decisions and operating performance (i.e. efficiency). In particular, this paper studies the relationship between the hold-up problem and operating efficiency in the regulated natural gas transport industry. We conducted a study that involved a two-step analysis based on financial data from 2005 until 2016. First, a Cost Stochastic Frontier model was applied to a panel of 8 companies operating worldwide, two of which had been held up in 2001. Then, the technical efficiency estimates were regressed in a panel data model to establish the possible correlation between contract breach and operating restraints. The results suggest that the companies whose real rates were decreased due to held-up contracts could have been motivated to reduce their inefficiency. Although rate levels might not affect efficiency straightforwardly, a rise in price of held-up firms could ease operating restrictions. Therefore, inefficiency in held-up companies might increase under rate revisions.