Regulatory Assessment of Investments by Telephone and Electric Utilities*

A utility's investments are included in the rate base if the expenditures can pass the “prudent” or “used and useful” tests. Regulators have a difficult time applying these tests to telephone companies because little is known about the demand for new services. Under current regulatory procedures, telephone companies face an incentive system which rewards the firm for successful entry into new markets, but because of the lack of information about the demand for new services, the cost of failures is absorbed by customers of existing services. We propose a rate-making standard that would insure that existing subscribers of telecommunications services will not subsidize the new services that are being introduced by local exchange telephone companies.