perverse incentives under incentive regulation

Incentives in incentive regulation, as in many other types of regulation, depend on operational details.  Pacific Bell’s public rate detail filings under its FCC interstate communications services price caps illustrate the importance of obscure details for the operation of price caps.

Among the thousands of Pacific Bell rate elements filed from 2003 to 2009 are some revenue-aggregate rate elements.  These elements have notional demand or rates (the notional form has actually changed across years) of 1.  For example, from 2003 to 2009 Pacific Bell filings have included “miscellaneous revenue” rate elements. The demand is reported as 1, and the rate as the total revenue, or vice versa. In the 2009 filing, such miscellaneous revenue totaled about $37 million.  Revenue for expediting orders has been similarly reported.  It totaled about $18 million in the 2009 filing.

Price caps don’t work effectively with such aggregate revenue elements.  These elements treat price caps as revenue caps.  Revenue caps have much different incentive properties than price caps.  A revenue cap constrains a firm’s ability to grow demand for its products.  In particular, providing extra services reported as miscellaneous revenue and providing additional expediting services appears like an increase in prices.  That’s fundamentally inconsistent with the basic idea of prices caps.

Both BellSouth and Pacific Bell have include aggregate credits (negative revenue) as rate elements in their price caps.  Since 1995, BellSouth has included in its price caps negative revenue, without any demand or rates, for Service Assurance Warranty (SAW) credits.  In filing year 2000, these credits amounted to about $11 million.  These credits are money BellSouth pays its customer for BellSouth service outages.[1]  Hence BellSouth service outages penalized through payments to its customers function like price reductions in price caps.  Price caps are not meant to encourage service outages.

Pacific Bell has also included aggregate credits (negative revenue) as rate elements in its price caps.  In the Pacific Bell filings, these credits are discounts associated with various types of volume and term rate plans.  Just as for miscellaneous revenue, the discount credit revenues are reported with demand of 1, and the rate as the total revenue, or vice versa.  From 2003 to 2008, the negative discount credit revenue averaged $28 million per year.  In Pacific Bell’s 2009 filing, discount credit revenue soared to $120 million.  These credits are not easy to associate with any particular prices, but they function like price reductions under price caps. Discount credits reported without any associated demand and rates obscure actual prices under price caps.

The obscurity of discount credits is not merely a theoretical problem.  Managed Value Plan (MVP) credits account for all the discount credits in Pacific Bell’s 2009 filing.  MVP billing discounts include commitment discounts that grow from 9% in year 1 to 15% in year 5.  MVP billing discounts also include service level assurance discounts of up to 2% for Pacific Bell failure to meet agreed service quality standards.[2]  To the extent that MVP credit revenue in Pacific Bell’s price cap filing includes such credits, the situation is like that for BellSouth’s Service Assurance Warranty credits.

Even assuming that Pacific Bell’s reported MVP credits in 2009 include service quality failure credits, the MVP credits are large relative to corresponding reported service revenues.  For example, Pacific Bell reported about -$37.8 million as “DS3 MVP credit” in its 2009 filing.  Pacific Bell also reported a total of $144.8 in price-cap DS3 revenue in its 2009 filing. Assuming the largest (year 5) MVP credit of 14% plus 2% for service quality failure implies DS3 price-cap MVP revenue of  $236 million.  That’s nearly $50 million greater than the DS3 revenue that Pacific Bell reported under price caps, before subtracting credits (negative revenue). Assuming an average discount of 12% (year 3 discount) plus 1% for service quality failures, and assuming half of reported DS3 revenue is not associated with MVP services, then reported price-cap MVP credits imply price-cap MVP service revenue $180 million greater than what was actually reported under price caps. These discrepancies highlight that Pacific Bell’s total discount credits are difficult to relate to particular price-cap service volumes and prices.

Incentive regulation creates additional incentives for regulatory obscurity.  Compared to more directed regulation, incentive regulation tends to be associated with more diffuse policy goals. More diffuse policy goals imply greater difficulties in comparing policy goals to outcomes.  Less focus on meaningful, concrete, outcome-oriented policy goals increases incentives for regulatory obscurity.

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Data: Pacific Bell rate detail, 1994-1999; Pacific Bell’s undetailed rate elements; BellSouth’s Service Assurance Warranty credits.


[1] BellSouth’s Service Assurance Warranty credits are described in BellSouth’s FCC Tariff No. 1, Section 2.4.4. For details on their application in a contract tariff, see Section 25.29.1.(E)(2)(b) (Contract Tariff – No. 026).

[2]  For MVP billing discounts associated with volume and term commitments, see Pacific Bell’s FCC Tariff No. 1, Section 22.3.(E)(3).  For MVP service level assurance discounts, see Section 22.3.(E)(4).

COB-38: attacks on bureaucrats

After a hard day of bureaucratic work, you might enjoy a bed-time gothic thriller:

A crime has been committed.

The country has been robbed in one of the greatest ripoffs and dirty deals in modern industrial history.  And in the commission of the crime, the nation’s largest and most socially minded corporation was defiled and destroyed.

A department of forensic accountants, sleeping soundly in a dark, clear night with crickets chirping vigorously all around in the bog in which they have camped after a long, fruitful day of team-building and sharing exercises, mysteriously begins to stir.  One accountant bolts upright in her sleeping bag and puts on her glasses.

So why was Ma Bell attacked?  Who is to blame for the rape of Ma Bell?  At whom can we point the finger?

“Something’s just not right,” she mutters to herself in the dark.  Listening carefully, she hears sounds of others moving.

A federal reguatory authority, usurping state powers, ignoring its mandate to protect the public interest.  …

Some government lawyers who saw a chance to make a reputation.

A press that failed to inform the public.

A Bell System management that was derelict in mounting an effective public information program.

“I hate to wake up my co-workers,” she reminds herself, “but this is an extraordinary situation. Something’s happening.”

Uncontrolled connection of terminal equipment

Destruction of end-to-end responsibility

Disregarding of the National Academy of Sciences panel’s warnings and recommendations

FCC’s Computer II decision depriving customers of modern services and stalling technological progress

Destruction of the integrated network [*]

Groping, stumbling, blindly crawling in different directions, the department finally manages to come together for a meeting around a recently filled-in hole at the center of the damp ground where they set up camp.  A quiet tenseness hangs over them like a dense fog.

“Something’s happening,” she finally says quietly but firmly.  Dead silence.  “Are you sure?”  ultimately responds the Senior Accountant who has only 312 more days of work until retirement.

Then everyone starts talking at once.  “How do we know?”  “Everything will be ok.”  “Don’t get upset, don’t get worried, don’t get nervous.  My mobile is auto-dialing the police.  The second the fog lifts, the phone will get enough bars to connect.  Oh, I should have switched to a service provider with better coverage!”  “I use T-Mobile.”  “Let’s just go back to bed.”  “Mind if I go to the bathroom?” “Not on my tent!”  “If we just stick together, we’ll be all right.”

And then, dear reader, you fell asleep.  Bureaucrats are impervious to attack and have no fear of change.

In other bureaucratic news, a true horror story from David Kassel at the Accountable Strategies blog:

Many terrorist groups, such as al-Qaeda and Hamas, have organizational structures that look like any bureaucracy, Helfstein says.  They are staffed with financial, operations, and strategy officers, and even public relations personnel.  Computers and hard drives seized by counterterrorism officials often contain bureaucratic forms outlining standard operating procedures.

If terrorists start acting like bureaucrats, they will be invincible.

Minoru Morita reports that government bureaucrats in Japan are scared.  He quotes a governnment bureaucrat saying:

Lately, when I meet government officials, they seem a little tense. They’ve been feeling this way ever since people starting realizing political change could occur, especially once the Democratic Party of Japan started talking about dismantling the bureaucracy and the mass media joined in the bureaucrat bashing. If the DPJ wins, it will join with the media to bash the bureaucrats even more.

The mass media cannot be serious about bureaucrat bashing.  Bureaucracy is the foundation of all civilizations.  It will endure as long as civilization endures.

Dave E. at Fish Fear Me observes that one must trust bureaucrats because laws are written incomprehensibly. Convoluted, obscure, and baroque laws form the basis for a meritocratic society.  Those who study laws the most thoroughly are the most successful. Bureaucracy and meritocracy are thus closely related.

Aguanomics features an excellent discussion on bureaucrats.  Consider this insightful comment:

The term “bureaucrat”, like “salesman” or “lawyer” carries a negative connotation these days; yet we rely on these people, and can be very very well served by them. I just returned from 3 days touring the Hetch Hetchy system in a group largely composed of what would be called bureaucrats. I came away very impressed with their dedication, pride, and professionalism. Theory dictates that monopoly agencies staffed with civil service employees should become stultified backwaters. Yet, many people in government or agency jobs really are driven by a commitment to lead a useful life, and to serve society.

This is a good example of the many intelligent and highly perceptive comments found on blogs, YouTube, Twitter, and many other fine internet sites.

That’s all for this month’s Carnival of Bureaucrats.  Nominations of posts to be considered for inclusion in next month’s carnival should be submitted using Form 376: Application for Bureaucratic Recognition.

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[*] Above quotes from Constantine Raymond Kraus and Alfred W. Duerig (1988), The Rape of Ma Bell: The Criminal Wrecking of the Best Telephone System in the World (Secaucus, NJ: Lyle Stuart) pp. 12-3, 14, 187.

Seneca’s Controversiae: effects of competition for attention


Elite men competed intensely for public attention in the Roman empire.  Oratory was a primary field of this competition.  According to one Roman authority:

it is impossible to imagine {a pursuit} in our state richer in advantages, more splendid in its prospects, more attractive in fame at home, more illustrious in celebrity throughout our whole empire and all the world.  … {“armed” with the art of oratory} a man can always bring aid to friends, succor to strangers, deliverance to the imperiled, while to malignant foes he is an actual fear and terror, himself the while secure and entrenched, so to say, within a power and a position of lasting strength [1]

Sophisticated Roman texts on oratory tend to emphasize the appeal of eloquent oratory to an elite audience. A leading public intellectual of the third century GC chronicled the triumphs of sophists through the ages.  He described the attention accorded to a sophist who in the second century GC held the prestigious Chair of Rhetoric in Rome:

they listened to him as to a sweet-voiced nightingale, struck with admiration for his facile tongue, his well-modulated and flexible voice, and his rhythms, whether in prose or when he sang in recitative.  So much so, that, when they were attending shows in which the vulgar delight — these were, generally speaking, performances of dancers — a messenger had only to appear in the theatre to announce that Adrian {holder of the Chair of Rhetoric} was going to declaim, when even the members of the Senate would rise from their sitting, and the members of the equestrian order would rise, not only those who were devoted to Hellenistic culture, but also those who were studying the other language {Latin} at Rome; and they would set out on the run to the Athenaeum, overflowing with enthusiasm, and upbraiding those who were going there at a walking pace. [2]

Ordinary court cases created most of the demand for instrumental oratorical skills in imperial Rome.  But as lawyers soon learn, much of the action in ordinary litigation is quite dull.  Competition among orators for attention, students, and speaking fees created, as if by an invisible tongue, scholastic oratory focused on sex and violence.  Here are some mock cases that were the subject of discussion about two millennium ago.

  • Law: A priestess must be chaste and of chaste {parents}, pure and of pure {parents}.
  • Discuss: A virgin was captured by pirates and sold; she was bought by a pimp and made a prostitute.  When men came for her, she asked for alms.  When she failed to get alms from a soldier who came to her, he struggled with her and tried to use force; she killed him.  She was accused, acquitted and sent back to her family.  She seeks a priesthood.
  • Law: Whoever catches an adulterer with his mistress in the act, provided that he kills both, may go free.  A son too may punish adultery on the part of his mother.
  • Discuss: A hero lost his hands in war.  He caught an adulterer with his wife, by whom he had a youthful son.  He told the son to do the killing.  The son refused.  The adulterer fled.  The husband now disinherits the son.
  • Law: A girl who has been raped may choose either marriage to her ravisher without a dowry or his death.
  • Discuss: On a single night a man raped two girls.  One demands his death, the other marriage.[3]

These sort of discussions now tend to be associated with legal education.  Law professors might solemnly describe them as fine training for developing the skill to think like a lawyer.  That’s quite sophistic.  These cases developed out of intense competition for attention, students, and speaking fees among the Roman equivalent of law professors.[4]  That competitive pattern is also seen in modern trends in the content of television talk shows, reality TV, and network news.  Intense competition for attention naturally generates representations of sex and violence.

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Read more:


[1] Tacitus, A Dialogue on Oratory, 5 (circa 102 GC).  Quoted from Complete Works of Tacitus, trans. Alfred John Church and William Jackson Brodribb (New York: Modern Library, 1942) pp. 737-8.

[2] Philostratus, Lives of the Sophists, 590 (circa 235 GC).  Quoted from Philostratus and Eunapius, trans. Wilmer Cave Wright (London: William Heinemann, 1961) pp. 231, 233.  The sophist described was Adrian the Phoenician (fl. mid-2’nd century GC).

[3] Seneca, Controversiae I, 2.1, 4.1, 5.1 (circa 37 GC).  Quoted from Declamations, trans. M. Winterbottom (London: William Heinemann, 1974) pp. 59, 105, 121.  I’ve added the tags “Law:” and “Discuss:”.

[4] Stanley Bonner, Roman Declamation in the late Republic and early Empire (Liverpool: Univeristy of Liverpool, 1949) p. 39 states:

the Senecan declamations were mostly delivered at gatherings of quite mature people. … it is also true that nearly all these themes were invented for and debated in the schools, as is witnessed by their survival in the Lesser Declamations attributed to Quintilian, where they are prefaced by the professorial sermo.  But most of the Senecan declamations appear to have been based upon debates where rival professors used the school-subjects to exhibit their powers and win the plaudits (or be shamed by the ridicule) of their contemporaries.

I think it more likely that the school subjects followed the professors, rather than the professors the school subjects.