Incentives, staffing, and benchmarking in a tight economy.
David W. Sosa, Ph.D. is a vice president and Virginia Perry-Failor is a manager, both in the San Francisco office of Analysis Group, Inc.
In several recent utility rate cases, regulators, under pressure to contain rate increases, have disallowed a portion of a utility’s claimed employee compensation expenses, citing local economic conditions and the need for austerity. Ratepayers should of course expect that the costs that lie behind the rate remain “just and reasonable.” However, if a utility is unable to recover reasonably incurred costs through its rates, its overall costs might rise, jeopardizing its financial health, Future ratepayers might end up paying more for service. Quality of service ultimately might suffer. Moreover, management’s ability to keep the ship running might be compromised if companies are denied flexibility to adopt viable alternative compensation packages, or if certain components of employee compensation are inappropriately disallowed.
In the typical rate case, the utility offers evidence that its employee compensation costs are reasonable. If the evidence proves insufficient, regulators may choose to disallow certain requested costs. The regulator must review the evidence and consider how a cost allowance will affect rates. However, if regulators focus on specific components of employee compensation—without adequately considering the reasonableness of total costs—then the rate order might do financial harm to the utility, and, in the long term, to ratepayers.