Lesser evil: Involuntary governance choices in the electricity industry

Abstract

Governmental liberalization policies provide a natural experiment for examining firms’ preferences for governance structures when adapting, voluntarily or involuntarily, to regulatory changes in the business environment. We investigate the involuntary governance choices of the energy firms in the Dutch electricity industry after the European electricity directives of 1996 and 2003. The governance choices are involuntary, because the directives prohibit the energy firms to organize their electricity transactions in the comparatively efficient governance solution of the vertically integrated firm. After the implementation of the directives, the energy firms claim to prefer quasi-integration instead of the market that is prescribed by the directives and national laws for the electricity industry. In this paper, we use transaction cost economics to study the governance structures. We complement the standard transaction cost analysis by incorporating adaptation as the process of adjustment between governance structures that can explain the involuntary governance choices. We explain how suboptimal governance choices are made, on the basis of both adaptation costs and misalignment costs. We present evidence on the relation between the preferred governance structures, expected adaptation costs and expected misalignment costs, based on expert information.