THE REGULATORY TREATMENT OF UTILITY DIVERSIFICATION

Recent regulatory reform has gradually relaxed the constraints on vert ical and horizontal diversification of public utilities. After earlier strategies of conglomerate diversification utilities more recently st arted to expand into domestic and international activities more closel y related to their core business. Sound diversification may improve co rporate performance, but raises complicated policy issues in firms ope rating in both regulated and unregulated markets. The paper studies th e problems of cross-subsidization, risk-shifting and profit-shifting t hat may result under conditions of partial regulation. Policy approach es that enable firms to pursue efficient diversification while reducin g inefficient diversification incentives created by partial regulation are being analyzed.