2015-21
To What Extent Do Public Interest and Private Interest
Affect Regulations?
An Empirical Investigation of Firms in Japan
Fumitoshi Mizutani
Eri Nakamura

To What Extent Do Public Interest and Private Interest AffectRegulations? An Empirical Investigation of Firms in Japan

Fumitoshi Mizutani* (Kobe University)
Eri Nakamura** (Kobe University)[Abstract]: Through an empirical analysis of firms in Japan, this paper investigates to what extent
the public interest and the private interest theories, respectively, explain the actual regulatory process.
Our estimation findings are as follows. First, the explanatory power of the public interest theory ishigher in non-public utility industries, while that of the private interest theory is higher in public
utility industries.

Second, rapidly growing industries become less regulated as they no longer need

government protection. Third, highly competitive industries become more regulated so as to retain
profit for individual companies. Fourth, price level has different implications among industries.
The negative coefficient in non-public utility industries supports the public interest theory, while thepositive coefficient in public utility industries supports the private interest theory.

[Key words]: Determinants of regulation; Corporate governance; Public interest theory; Privateinterest theory[JEL classification]: L44, L51, L52

1. Introduction
According to welfare economics, regulations are constructed to improve social welfare inindustries where there are market failures.

However, not all regulations implemented in reality

seem to be designed with social welfare in mind, nor are they always drawn up in the most desiredform.

For example, some regulations work to protect politically well-connected companies fromsevere competition.

Lack of relevance to social welfare can also be seen in the opposition

campaigns of involved interest groups in the deregulation process, which results in deregulation
being implemented in a distorted form.

Observation suggests that actual regulation is tamperedwith by the intervention of certain interest groups.
*

Correspondence author: Graduate School of Business Administration, Kobe University, 2-1 Rokkodai,
Nada-ku, Kobe 657-8501, Japan. E-mail: toshi@kobe-u.ac.jp**
Graduate School of Business Administration, Kobe University, 2-1 Rokkodai, Nada-ku, Kobe 657-8501,
Japan. E-mail: enakamura@person.kobe-u.ac.jp1Previous studies on regulatory economics, such as Stigler (1971) and Peltzman (1976),
have recognized that the actual regulatory process does not necessarily reflect the implications of
welfare economics.

These researchers propose two perspectives: the public interest theory and theprivate interest theory.

The public interest theory assumes that regulations are organized tomaximize social welfare, as is typically discussed in traditional welfare economics.

The privateinterest theory, on the other hand, assumes that regulations are the result of a power balance among
various interest groups, including the government, companies, consumers, and community residents.
It is the purpose of this paper to investigate, by empirical methodology, which theory—the
public interest or the private interest—better explains the actual regulatory process.
makes several contributions to the existing field.
two theories in real regulatory situations.

Our paperFirst, we empirically compare the fitness of these

While certain previous studies recognize the two theories

in their analytical framework, empirical research has rarely been implemented.

For example,

Peltzman (1976) focuses on the theoretical generalization of the private interest model using apolitician’s objective function.

Moreover, although some studies use the empirical method, most

focus only on one theory or the other, and do not compare the two. For example, although Stigler(1971) and Primeaux Jr. et al. (1984) use an empirical model to investigate the private interest theory,
they do not consider the public interest theory at all.
Second, we generalize the issue for multiple industries by using the industry-level total
regulation index.

The total regulation index, or “regulation weight,” expresses the strength of

regulations in an industry and can be compared among industries.

Using this index enables us to

implement an analysis of multiple industries and thus to draw a general implication which cannot be
obtained in an intra-industry analysis.
in a specific industry.

In fact, most existing studies focus on a specific regulation

For example, Benmelech and Moskowitz (2010) examine usury laws as aproxy for financial regulation, while Dnes and Seaton (1999) investigate deregulation in regional
electricity companies.

Berg & Jeong (1991) focus on incentive regulation for electric utilities.

Third, we include multiple factors such as corporate governance and market price indetermining the fitness of the two theories. Most previous studies have viewed the regulatory
process from a single perspective.

For example, Kroszner and Strahan (1999) use only the sign ofthe competition variable to determine which theory is correct.

In this paper, we define the fitnessof the two theories based on various factors including corporate governance, governmental
intervention, industrial growth rate, competition, and market price index.

This enables us to coverbroader aspects of the two theories and interpret each theory appropriately.
Fourth, we calculate the percentages of the fitness of the two theories with regard to public
utilities and non-public utilities.

As stated above, previous literature rarely compares the twotheories in an empirical model.

This means that previous work assumes implicitly that only one ofthese theories is correct. However, we assume that both theories explain the real situation to some2

extent but that the percentage of fitness differs with each.
between public utilities and non-public utilities.

Moreover, we note the difference

Since our regulation index includes all types ofregulation programs in an industry, we consider the possibility that the dominant type of programs
can differ with industrial characteristics. In fact, our result shows that the fitness of each theory
differs significantly in public utilities and non-public utilities.
This paper consists of five parts after the introduction.

Section 2 explains theoreticalbackground by overviewing previous literature on the regulatory process. Section 3 shows ourmodel structure for the empirical analysis. Section 4 explains the data and the variables used in theanalysis.

Section 5 shows the empirical results, and Section 6 summarizes the conclusions.

2. Theoretical background
2.1 Public interest theory and private interest theory
As Vickers and Yarrow (1988) note, previous literature has proposed mainly two theories
to explain how regulations are constructed: the public interest theory and the private interest theory.
The public interest theory assumes that regulation is formulated to correct various types of market
failures and to improve social welfare, as seen in traditional welfare economics.

Under thisassumption, regulations are constructed by a government with the intention of maximizing social
welfare, and no other interest groups can intervene in the regulatory process.

That is, as Viscusi(2005) indicates, this theory assumes that “under what kind of situation the regulation should beformulated” directly explains “under what kind of situation the regulation is formulated.”
However, in reality, sometimes regulations are not created to address market failures(Posner 1974).

Stigler (1971) argues that regulatory processes are interposed by various interest

groups such as companies, trade groups, consumers’ unions, and community residents.

What iscalled the private interest, or capture, theory is the idea that rather than correcting market failures,
regulation is designed to further the interests of lobbying groups which control the regulatory
process.

Since Peltzman (1976) generalized Stigler’s (1971) model of the private interest theory,some studies, such as Primeaux Jr. et al. (1984), Ros (1999), and Feijen and Perotti (2006), haveapplied it in their empirical analysis.

For example, Primeaux Jr. et al. (1984) test Peltzman’s modelby the logit model using data from the electricity industry.

While there is still room for

improvement in the private interest theory in that it cannot sufficiently explain some regulations forsocial, environmental, health and safety issues, this theory is supported by evidence from empiricalstudies on various regulation programs and various industries: Dnes et al. (1998) for price cap
regulation in the UK electricity industry, Dnes and Seaton (1999) for deregulation policy in the UK
regional electricity industry, Kroszner and Strahan (1999) for US banks, Feijen and Perotti (2006)
for financial regulation in manufacturing industries in 15 countries, Benmelech and Moskowitz(2010) for US financial regulation, and Smyth and Soderberg (2010) for regulator decisions in the3

Swedish electricity market.

2.2 Fitness of each theory with reality
Researchers have tried to determine which of the two theories—public interest or privateinterest—reflects reality, and to identify the factors affecting regulatory formation.

As stated above,

the private interest theory is supported in various areas, but most researchers do not compare it withthe public interest theory in their analysis.

Similarly, most welfare economics studies based on the

public interest theory overlook the private interest theory.

On the other hand, some studies onregulatory economics include both theories in the same framework and determine which is supported
by empirical analysis.

Kroszner and Strahan (1999) and Benmelech and Moskowitz (2010) support

the private interest theory, while Smyth and Soderberg (2010) support the public interest theory.
However, is it true, as most previous studies assume, that only one of the two theories
reflects reality? Rather, we consider that both theories can explain reality to some extent, though
the fitness of each theory differs. For example, the government might try to maximize social
welfare during a regulatory process in which interest groups have already intervened.

To examine

this possibility, we employ a “public interest and private interest” approach instead of a “public
interest versus private interest” approach.
When determining which theory is supported or identifying the factors affecting regulatory
formation, previous studies use various factors, which we have grouped into five categories,
according what each is related to: governance structure, governmental intervention, industrial
characteristics, competition, and market price.
the various forms.

First, governance structure is commonly included in

Stigler (1971) uses the presence of a cohesive opposition, Primeaux Jr. et al.

(1984) use the influence of stakeholders such as residential consumers, industrial consumers, andnatural gas producers, Ros (1999) uses private ownership, Feijen and Perotti (2006) use external
dependency of finance, and Smyth and Soderberg (2010) use variables related to decision making(e.g. private ownership, governmental ownership, decisions in favor of customers, decisions in large
utilities) in their analysis.

In fact, since governance structure disciplines and guides

decision-makers toward a certain direction favorable to the governing actor, it can influence theregulatory process.
Second, governmental intervention is also frequently mentioned, as it reflects thegovernment’s intention to improve social welfare.

We separate it from governance structure,

though one might consider governmental intervention as a type of governance structure.
Governmental intervention is different, however, in that it intends to maximize social welfare while
governance structure intends to maximize the interest of specific groups such as companies orbusiness groups.

This means that governmental intervention is related to the public interest theory.

Third, industrial characteristics include the industrial growth rate and profit rate.
4

Berg &

Jeong (1991) use a firm’s margin, Dnes and Seaton (1999) use abnormal market returns earned by
special interest groups such as regional electricity companies, generators, and foreign companies,
and Ros (1999) uses yearly growth.
Fourth, competition is also commonly used to test the two theories.

Kroszner andStrahan (1999) include small firms’ share of the number of firms in the state, Ros (1999) includes thecompetition level, Feijen and Perotti (2006) use industry-level number of establishments before acrisis as an explanatory variable, and Benmelech and Moskowitz (2010) use the bank Herfindahl
concentration index.
Fifth, since Peltzman (1976) states that the price of goods influences decision-makers’
objective function, empirical studies such as Ros (1999) include the price variable.

Price is themain variable by which the government measures the monopoly level and also the factor that affects
interest groups’ incentives to capture the regulatory process.
In summary, factors related to governance structure are considered to belong to the privateinterest theory in its original nature, while those related to governmental intervention belong to the
public interest theory. The other factors—industrial characteristics, competition, and price—can be
determined on a case by case basis, since these factors can influence both the government’s incentive
to protect an industry and the interest group’s incentive to capture the regulatory process to retain
profit.

Which incentive dominates the other is a question to be determined by empiricalobservation.
Although the above-mentioned factors are all shown to be important in the literature,
analysis considering these factors together in the same model has rarely been implemented.

Most

studies focus on some of the above factors, depending on the industry being investigated. For
example, Kroszner and Strahan (1999), who use data on the bank industry, examine the competition
variable to test the two theories.

Moreover, the research interest of the existing literature is todetermine which theory—the public interest or the private interest—reflects reality. Thus, it has notbeen examined to what extent each theory can explain the real regulatory process. In this paper, we
try to answer this question by considering the two theories in the same model including all theimportant factors mentioned above.

3. Model3.1 Model structure and methodology
Our research method is based on Kroszner and Strahan (1999).

They determine whether

public interest or private interest theory reflects reality by the sign of the main variable, competition.
Similarly, we measure the explanatory powers of the public and the private interest theories by thesigns of multiple variables: industrial characteristics, competition, and price index.

We usemultiple variables to determine the supported theory, which enables us to view the regulatory5

process from multiple perspectives.

In our analysis, a negative variable sign supports the public

interest theory, while a positive sign supports the private interest theory.

In addition to the above

variables, we assume that there are certain factors that should be considered in advance as
public/private interest-related. These are the structure of corporate governance and governmental
intervention.

We will explain the characteristics of each variable later.

We consider that both the public interest and the private interest theories have some
explanatory powers applicable to real situations.
theory after the estimation.

Thus, we calculate the explanatory power of each

Summing up the magnitudes of the variables supporting the same

theory enables us to measure the whole explanatory power as a theory.

That is, the coefficients ofsignificant variables showing the positive sign are adjusted and summed up to measure the fitness ofthe private interest theory, and the absolute values of the coefficients of variables significantly
showing the negative sign are also adjusted and summed up to measure the fitness of the public
interest theory.

Since all variables are standardized before the estimation, the magnitude of thevariables can be compared with each other in themselves, even if the unit of measurement isdifferent.
In this paper, we consider the public interest and the private interest theories, as shown in
Figure 1.

MarketCorporate Governance(Regulation Strength)
A: Public interest
theoryCompany

Government

B: Private interest theory

Figure 1 Public interest theory and private interest theory

Arrow A shows the public interest theory and arrow B shows the private interest theory.
In the public interest theory, regulations are constructed by the stand-alone government directlyinterfering in the market to maximize social welfare.

In the private interest theory, the governmentis influenced by certain interest groups, say companies, and constructs regulations for the sake ofthese groups. In other words, the interest groups indirectly interfere in the market through the6government. The left side of Figure 1 shows that companies are also influenced by the structure ofcorporate governance, such as ownership by influential shareholders.

The border between

corporate governance and the company itself can be ambiguous; for example, some monitoring
systems exist inside a company; these two actors are enclosed respectively in dotted boxes.
Based on the above method, we consider the characteristics of the explanatory variables
used in the analysis below.

The explained variable is the regulation strength in the market.

As

more regulations are implemented in the industry, the value of the regulation strength becomes high.
By regulation strength, we mean here all types of regulations related to price, entry, environmental
protection, health and safety, etc.

This regulation strength is explained by the structure of corporate

governance, governmental intervention, industrial characteristics, competition, and price index.
As Figure 1 shows, the structure of corporate governance belongs to the private interest
theory.

Arrow B expresses the fact that the structure of corporate governance influences thecompany’s decision-making and then the government’s action with regard to the market.

Thus, thevariables related to corporate governance are considered in advance as variables of the privateinterest theory.

In our empirical analysis, whether the signs of the governance variables arenegative or positive, they are interpreted as the impacts of private interest groups.
depends on the interest of the capturing group.

The sign

If fewer regulations are favorable for the capturinggroup, the sign will be negative, while if they desire more regulations the sign will be positive. As
the variables of corporate governance, we include the following seven: managerial ownership,ownership by large shareholders, ownership by financial institutions, foreign ownership, control by
the parental company, M&A threat, and the power of trade groups.
Figure 1 also shows that direct governmental intervention belongs to the public interest
theory.

The government directly interferes in the market as shown by arrow A.

Thus, regardlessof the sign of the coefficient, governmental intervention is deemed to be the public-interest impact inthe empirical analysis.

The sign merely shows the direction of the government’s intention.

When

more regulations are favorable for the market, the industry becomes highly regulated, which
generates the positive sign.
sign will be negative.

When the government considers fewer regulations as desirable, theSometimes the latter case can be observed with deregulation in the realworld, which is also direct intervention from the government into the market.
governmental intervention, we include governmental ownership in the model.
1

As a measure of1

One might consider that governmental intervention can reflect the interest of private groups and thus
belongs to the private interest theory. Surely, in Figure 1, there is another arrow from “Government” to“Market,” which belongs to arrow B. However, governmental ownership, the proxy we used here forgovernmental intervention, is relatively independent of the other groups, and as a result, we candistinguish arrow A from arrow B. This is because, when it comes to shareholding, the government is
expected to behave as an independent owner and monitor of the company, as are the other shareholders.
It is natural to assume that shareholders observe, monitor, and make a decision independently from thecompanies they own, as most discussions on corporate governance implicitly assume. Thus, in thispaper, the governmental direct intervention in the form of ownership corresponds to the public interest7In addition to these variables, we include industrial characteristics, competition, and priceindex as explanatory variables in the model.

These are the variables whose signs are used todetermine whether the public or the private interest theory is supported.

We include the growth rateof the industry as the variable of industrial characteristics, the number of companies in the industry
and the inverse of the Herfindahl-Hirschman Index (HHI) as variables of competition, and theinverse of Consumer Price Index (CPI) as price variables.

We explain the interpretation of eachvariable below.
First, we can interpret the positive sign of the growth rate of the industry to indicate thatwhen companies are able to obtain abundant resources from the market to be used for capturing,
more regulations are made for the sake of these companies.
private interest theory.

Thus, the positive sign supports theConversely, the negative sign supports the public interest theory.

When

the industry grows, since the existing companies can sustain enough profit to survive, thegovernment does not need to protect the industry.

Similarly, as high-growth industry attracts many

competitors in pursuit of excess profit, the problems of monopoly are reduced, which results in lessnecessity for the government to regulate.
Second, the positive sign of the competition variables means that regulations are increasedby the capture of existing companies to sustain enough profit to survive.

Conversely, the negative

sign means that the government regulates more to avoid problems with monopoly when there arevery few companies in the industry.
Third, the price variable can be interpreted as follows.

In the private interest theory,when the price goes down, existing companies participate more in political activities to keep theirprofit. Thus, the industry becomes highly regulated.

On the other hand, in the public interest

theory, when the price becomes lower, regulations are relaxed since monopoly problems are reduced,
which leads to less necessity for the government to interfere.
In summary, we can express our model as equation (1).

REG = f (CGi, GOVj, INDk, COMPl,, PRICEm).
Where

(1)

REG : strength of regulations in the industry,CGi: corporate governance (i =MANAGE (the managerial ownership), LARGE(the ownership by large shareholders), FINANCIAL (the ownership by financial
institutions), FOREIGN (the foreign ownership), PARENT (the control by theparental company), M&A (the M&A threat), TGROUP (the power of tradegroups),GOVj : government (j = OWN (the governmental ownership)),
INDk : industry structure (k = GROWTH (the growth rate of the industry)),

theory.

8

COMPl : competition (l = NUM (the number of companies in the industry),
INVHHI (the inverse of HHI)),PRICE: price (m =INVCPI (the inverse of CPI)).
We take the inverses of HHI and CPI so that we can interpret the negative sign as the
public-interest impact and the positive sign as the private-interest impact.

3.2 Empirical model
Based on equation (1), we specify the empirical model here.

As stated above, we

consider that the fitness of each theory differs between public utility industry and non-public utility
industry.

In order to reflect the difference between them, we add the cross terms of the variables

shown above and public utility dummy (P), which generates the empirical model expressed as
equation (2).
REG= 0 +1 CGMANAGE +2 CGLARGE +3 CGFINANCIAL +4 CGFOREIGN+5 CGPARENT +6 CGM&A +7 CGTGROUP +8 GOVOWN +9 INDGROWTH+10 COMPNUM +11 COMPINVHHI +12 PRICEINVCPI +1 PCGMANAGE+2 PCGLARGE +3 PCGFINANCIAL +4 PCGFOREIGN +5 PCGPARENT+6 PCGM&A +7 PCGTGROUP +8 PGOVOWN +9 PINDGROWTH+10 PCOMPNUM +11 PCOMPINVHHI +12 PPRICEINVCPI + .

(2)

The coefficients of the variables which are not multiplied by the public utility dummyshow the impact in non-public utility industry, while the sum of the coefficients of cross terms andnon-cross terms shows the impact in public utility industry.

For example, 10 shows the effect ofcompetition in non-public utility industry, while the sum of 10 and 10 shows the effect in public
utility industry.

All variables except P are standardized.

As stated above, in order to calculate the explanatory powers of the public and the privateinterest theories, the adjusted magnitude is calculated for each variable showing statisticalsignificance after the estimation. It is defined as the ratio of the impact of the variable to the sumof the impacts of all significant variables.

In our model, the negative sign of the coefficient

supports the public interest theory while the positive sign supports the private interest theory.

The

exceptions are the variables of corporate governance, which belong to the private interest theory
regardless of the sign, and the governmental intervention, which belongs to the public interest theory
regardless of the sign.
Since we assume in advance that corporate governance variables all belong to the privateinterest theory, the signs must be positive. Therefore, the adjusted magnitude of each variable ofcorporate governance is calculated as:
9For non-public utilities,

For public utilities,

Similarly, since we assume in advance that governmental intervention belongs to the
public interest theory, the sign ought to be negative.

Therefore, the adjusted magnitude ofgovernmental intervention is calculated as:
For non-public utilities,

For public utilities,

On the other hand, variables IND, COMP, and PRICE have the meaning of the estimatedsign. Thus, the numerator is not taken as absolute value.
For non-public utilities,

For public utilities,

Finally, we calculate the fitness of each theory into public utility and non-public utility
industries respectively.

The fitness of public interest theory can be defined as the absolute value ofthe sum of the adjusted magnitude of all significant variables whose signs are negative and that ofprivate interest theory as the sum of the adjusted magnitude of all significant variables whose signs
are positive. The total of these two values of fitness is equal to 1 in each public and non-public
utility industry.

Thus, the fitness of each theory is expressed in the value it takes between 0 and 1.

10

4. Data and variable
We use Japanese 643 industry-level observations in 2002.

Industrial categorization isbased on the middle class of the Japan Standard Industrial Classification.

We collected the datafrom JIP Database 2006 by the Research Institute of Economy, Trade & Industry for the regulation
data and Needs Financial Quest by Nikkei Digital Media for all other data.
annual year in which we can obtain all the data for the variables.
statistics of the variables are shown in Table 1.

Year 2002 is the latest

The definition and summary

All variables except P are standardized to compare

the magnitudes.

**************[Table 1]**************REG is the regulation weight calculated in JIP Database 2006.
of this weight is as follows.

The calculation method

First, each business sector in an industry is categorized into

“regulated” or “non-regulated” based on the regulatory documents by the Management andCoordination Agency in Japan.

Next, the added value of each business sector is calculated.

Then,

the total added value of all regulated sectors and of all regulated and non-regulated sectors is
generated.

As a result, regulation weight expresses the ratio of the added value in regulated

business sectors to that in all sectors in an industry.
As the measurement of CGMANAGE, CGLARGE, CGFINANCIAL, and CGFOREIGN, we calculated
the ratios of shares held respectively by company managers, top ten shareholders, financial
institutions, and foreign owners, to the total number of shares with respect to company, and take theindustrial average based on the middle class of the Japan Standard Industrial Classification.
CGPARENT is the ratio in an industry of the companies with a parent company.
an industry of companies having experienced M&A as a buyer or a seller.

CGM&A is the ratio in

CGTGROUP is the ratio in

an industry of the companies belonging to some sort of trade group. GOVOWN is the ratio of shares
held by the government to the total number of shares.
INDGROWTH is the industrial average of the growth rate of revenues from the previous year.
COMPNUM is the number of companies in the industry.
Herfindahl-Hirschman Index (HHI) based on revenues.

COMPINVHHI is the inverse of the

We take the inverse of HHI so that ahigher value of COMPINVHHI means a higher level of competition. Similarly, PRICEINVCPI is theinverse of Consumer Price Index (CPI).

As we take the inverse of CPI, PRICEINVCPI means thelowness of the price.
Last, we generate the cross terms of the above variables and the public utility dummy, P.
11

P takes a value of one if the industry belongs to the public utility industry category, a value of zerootherwise.

These cross terms express the difference between the public and the non-public utility

industries.

The coefficient of non-cross term shows the impact in non-public utility industry, while

the sum of the coefficients of non-cross term and cross term of the same variable shows the impact
in public utility industry.

5. Estimation results
The estimation result by OLS is shown in Table 2.

**************[Table 2]**************

Model 1 is the full model shown as equation (2), Model 2 excludes GOVOWN from Model 1,
and Model 3 excludes all cross terms from Model 1. The adjusted magnitude of each variable iscalculated based on equations (3) through (8).

The fitness of each theory is defined as the absolutevalue of the sum of the adjusted magnitudes of all significant variables whose signs are negative forpublic interest theory and positive for private interest theory.

The value in the dark black box

shows the result in non-public utility industry and that in the light black box shows the result inpublic utility industry.

Note that the latter is calculated as the sum of the coefficients of cross term

and non-cross term of the same variable.
The most important result is that the explanatory power of public interest theory is higher
in non-public utility industry while that of private interest theory is higher in public utility industry.
In Model 1 of Table 2, the fitness of public interest theory is 80.4% and that of private interest theory
is 19.6% in non-public utilities, while in public utilities, the fitness of public interest theory is only
24.3% and that of private interest theory is 75.7%. This result does not support the traditional
assumption that the government is keen to interfere in public utility industry while it tends to leave
control to the market in non-public utility industry.
We can interpret our result as follows.

Since non-public utility industry is not highly

regulated in its original nature, the government might have high incentive to interfere in this industry.
Generally, companies in non-public utility industry tend to pursue their own economic gain rather
than to maximize the social welfare.

Thus, the government might try to lead them to consider moreclosely the public interest. As a result of the intense interference of the government, other interest
groups are excluded from the determination process of regulations.
12This is consistent with theresult that most of the other actors such as shareholders and trade groups are not significant in
non-public utility industry.
On the other hand, since public utility industry is highly regulated in its original nature, thegovernment has less incentive to interfere in this industry.

Rather, considering the recent criticism

that public utilities are inefficient because of government protection, the government has incentive towithdraw and leave control to the market.

Thus, the regulatory process is subject to interference byother interest groups. This is consistent with the result that various factors such as corporate
governance and industrial characteristics are significant in public utility industries.
Next, we will discuss each variable used to determine the supported theory by its estimatedsign. First, the industrial growth rate has a negative effect in public utility industry, which suggeststhat highly growing industry becomes less regulated probably because the government no longer
needs to protect the industry.
utility industry.

Conversely, the industrial growth rate is not significant in non-public

The number of companies in the industry has a positive effect in public utility

industry, which suggests that a highly competitive industry becomes more regulated to sustain profit
for each company.

However, the other measure of competition, the inverse of HHI, is not

significant in either industry.

The inverse of CPI has a positive impact in public utility but anegative impact in non-public utility industry.

This suggests that when the price is high, theindustry is strongly regulated in non-public utility industry.

On the other hand, in public utility

industry, when the price is low, the regulation is strengthened.
Since various cross terms in Model 1 are significant, Model 1 seems to be better thanModel 3.

A model excluding important variables is severely biased, as is known in econometrics.

Although the public utility dummy in Model 3 is significant, there are differences which cannot be
controlled by an intercept dummy.

The slopes of some variables are different depending on thegovernment’s incentive to interfere in the industry.

This suggests the necessity of analysis

considering the fundamental differences between public and non-public utility industries.
Similarly, governmental ownership is important and should not be excluded from themodel, as the comparison of Models 1 and 2 shows.

In Model 2, which excludes GOVOWN andPGOVOWN, the explanatory power of private interest theory in non-public utility industry is 0%,
while 26.2% in Model 1, which includes these two variables.

Based on Model 2, we might

wrongly conclude that the private interest theory has no explanatory power in the non-public utility
industry. The importance of governmental ownership is shown by the result in Model 1 that both of
GOVOWN and PGOVOWN are significant.
In addition, the absolute value of the adjusted magnitude of price index is high in bothpublic and non-public utility industries. This means that regulation strength is determined largelyby the price level. This is consistent with previous studies such as Peltzman (1976) and Ros (1999)
that conclude the price is the important basis for the regulation.
13

However, as the sign of the priceindex is not the same, the interpretation differs between the public and non-public utility industries.
The negative coefficient in non-public utility industry supports the public interest theory, while thepositive coefficient in public utility industry supports the private interest theory.

6. Conclusion
The purpose of this paper is to investigate by empirical analysis to what extent the public
interest and the private interest theories respectively explain the actual regulatory process. Our
paper makes several contributions to the existing field. First, we empirically compare the fitness ofthese two theories with regard to the real situation. Second, we generalize the issue for multiple
industries by using an industry-level total regulation index.

Third, we include multiple factors suchas corporate governance and market price in determining the fitness of the two theories.

Fourth, we

calculate the percentages of the fitness of the two theories in public utilities and non-public utilities.
Our estimation result shows the following point.

First, the explanatory power of public

interest theory is higher in non-public utility industry while that of private interest theory is higher inpublic utility industry.

The fitness of public interest theory is 80.4% and that of private interest

theory is 19.6% in non-public utilities, while in public utilities, the fitness of public interest theory is
only 24.3% and that of private interest theory is 75.7%.
Second, high-growth industry becomes less regulated since the government no longer
needs to protect it.
each company.

Third, highly competitive industry becomes more regulated to sustain profit for

Fourth, the price level has different implications among industries.

The negative

coefficient in non-public utility industry supports the public interest theory, while the positivecoefficient in public utility industry supports the private interest theory.
Moreover, governmental ownership is important and thus should not be excluded from themodel.

Finally, our result supports previous studies concluding that price is the most importantbasis for regulation.

References
Benmelech, E. and T.J. Moskowitz (2010) “The Political Economy of Financial Regulation:
Evidence from U.S. State Usury Laws in the 19th Century,” Journal of Finance, 65(3):pp.1029-1073
Berg, S. V. and J. Jeong (1991) “An Evaluation of Incentive Regulation for Electric Utilities,”
Journal of Regulatory Economics, 3: pp.45-55
Dnes, A. W., D. G. Kodwani, J. S. Seaton, and D. Wood (1998) “The Regulation of the United
Kingdom Electricity Industry: An Event Study of Price-Capping Measure,” Journal ofRegulatory Economics, 13: pp.207-225
Dnes, A. W., and J. S. Seaton (1999) “The Regulation of Electricity: Results from an Event Study,”
14

Applied Economics, 31: pp.609-618
Feijen, E. and E. Perotti (2006) “Deliberate Financial Fragility,” Working Paper, University of
Amsterdam
Kroszner, R.S. and P.E. Strahan (1999) “What Drives Deregulation? Economics and Politics of theRelaxation of Bank Branching Restrictions,” Quarterly Journal of Economics, 114(4):pp.1437-1467
Peltzman, S. (1976) “Toward a More General Theory of Regulation,” Journal of Law and Economics,
19(2): pp.211-240
Posner, R. A. (1974) “Theories of Economic Regulation,” Bell Journal of Economics andManagement Science, 5(2): pp.335-358
Primeaux Jr., W. J., J. E. Filer, R. S. Herren, and D. R. Hollas (1984) “Determinants of Regulatory
Policies toward Competition in the Electric Utility Industry,” Public Choice, 43(2): pp.173-186
Ros, A. J. (1999) “Does Ownership or Competition Matter? The Effects of Telecommunications
Reform on Network Expansion and Efficiency,” Journal of Regulatory Economics, 15: pp.65-92
Smyth, R. and M. Soderberg (2010) “Public Interest Versus Regulatory Capture in the Swedish
Electricity Market,” Journal of Regulatory Economics, 38:pp.292-312
Stigler, G.J. (1971) “The Theory of Economic Regulation,” Bell Journal of Economics andManagement Science, 2(1): pp.3-21
Vickers, J. and G. Yarrow (1988) Privatization: An Economic Analysis, London: MIT Press.
Viscusi, W. K., J. E. Harrington, and J. M. Vernon (2005) Economics of Regulation and Antitrust, 4th
Edition, MIT Press.

15

Table 1 Summary Statistics
Variable

Definition

Mean

Std.

Min

Max

Dev.
REG

Regulation weight-0.009 0.992-0.535 2.284

CGMANAGE

Industrial average of managerial ownership

0.015

1.003

-0.800 6.001

CGLARGE

Industrial average of ownership by top ten 0.042

0.960-2.266 2.408

0.989-1.461 3.528

shareholders
CGFINANCIAL

Industrial average of ownership by financial 0.027
institutions

CGFOREIGN

Industrial average of foreign ownership

0.014

1.004

-0.775 6.376

CGPARENT

The rate of companies under parent companies -0.041 0.654-0.157 6.753

in the industry
CGM&A

The rate of companies having experienced -0.028 0.688-0.136 9.218

M&A in the industry
CGTGROUP

The rate of companies belonging to trade 0.019

0.972-2.967 0.633

groupsGOVOWN

Industrial average of governmental ownership

0.002

1.009

-0.087 21.782

INDGROWTH

Industrial average of the growth rate of 0.000

1.000-1.069 17.465

revenues from the previous year
COMPNUMThe number of companies in the industry

0.008

1.007

-0.482 13.995

COMPINVHHI

Inverse of Herfindahl-Hirschman Index (HHI) 0.006

1.003-0.642 10.106

based on revenues
PRICEINVCPI

Inverse of Consumer Price Index (CPI)-0.005 1.008-3.593 7.613

PCGMANAGE

Cross term of P and CGMANAGE

0.002

1.010

-0.085 23.504

PCGLARGE

Cross term of P and CGLARGE

0.004

1.010

-0.197 7.399

PCGFINANCIAL

Cross term of P and CGFINANCIAL

0.004

1.010

-0.179 9.020

PCGFOREIGN

Cross term of P and CGFOREIGN

0.003

1.010

-0.153 11.856

PCGPARENT

Cross term of P and CGPARENT

0.001

1.006

-0.069 20.270

PCGM&A

Cross term of P and CGM&A

0.000

1.006

-0.039 25.476

PCGTGROUP

Cross term of P and CGTGROUP-0.005 0.987-0.207 5.222

PGOVOWN

Cross term of P and GOVOWN

0.001

1.010

-0.065 21.487

PINDGROWTH

Cross term of P and INDGROWTH

0.000

1.000

-0.523 25.299

16

PCOMPNUM

Cross term of P and COMPNUM

0.001

1.010

-0.150 15.913

PCOMPINVHHI Cross term of P and COMPINVHHI

0.002

1.005

-0.177 9.396

PPRICEINVCPI

Cross term of P and PRICEINVCPI-0.011 0.977-0.219 4.606

P

Publicutilitydummy(public

industry=1, otherwise=0)(1) The number of observations is 643 for all variables.
(2) All variables are standardized.

17

utility 0.044

0.204

0.000

1.000

Table 2 Estimation result
Model 1

Coef.

Model 2

Std. Err.

CGMANAGE

0.038(0.052)CGLARGE

0.075 *

(0.045)CGFINANCIAL-0.029(0.051)CGFOREIGN

0.021(0.042)CGPARENT-0.018(0.057)

CGM&A-0.015CGTGROUP

Adjusted

fitness of themagnitude theory

Coef.

Model 3

Std. Err.

Adjusted

fitness ofmagnitude the theory

Coef.

Std.

AdjustedErr.

magnitude

0.041(0.051)

Non-public

0.022(0.049)0.070(0.044)

utilities

0.077 *

(0.045)-0.027(0.051)-0.048(0.050)0.020(0.042)

public0.017(0.041)

public interest-0.018(0.057)

interest

0.060(0.057)(0.037)

theory-0.015(0.037)

theory0.008(0.039)-0.042(0.047)80.4%-0.042(0.047)100%-0.056(0.046)GOVOWN-0.025 ***(0.009)-0.010(0.021)INDGROWTH

0.066(0.064)

private

0.066(0.064)

private-0.041(0.050)COMPNUM

0.008(0.046)

interest theory

0.008(0.046)

interest

0.038(0.055)COMPINVHHI-0.001(0.060)

19.6%

0.000

(0.060)theory-0.029(0.062)

PRICEINVCPI-0.282 ***(0.063)-0.282 ***(0.063)-0.277 ***(0.059)PCGMANAGE-0.066(0.054)-0.077(0.053)Public

PCGLARGE-0.012(0.125)0.000(0.124)

utilitiesPCGFINANCIAL-0.167(0.126)

public interest-0.157(0.125)PCGFOREIGN-0.053(0.063)

theory-0.065(0.060)publicPCGPARENT

0.076 **

(0.031)0.109 24.3%

0.070 **

(0.029)0.104 interest

0.196 Non-public
utilities-0.065-0.738Public utilities
0.107

18

-1.000 0%

0.150-0.540PCGM&A

0.033(0.027)0.049 **

(0.023)0.073 theory

PCGTGROUP-0.034(0.197)

private-0.049(0.196)

23.0%

PGOVOWN

0.041 *

(0.023)-0.024 interest theory

PINDGROWTH-0.153 ***(0.051)-0.219 75.7%-0.154 ***(0.051)-0.230 private

PCOMPNUM

0.113 **

(0.054)0.162

0.107 **

(0.053)0.161 interest

PCOMPINVHHI-0.021(0.127)-0.025(0.129)theoryPPRICEINVCPI

0.547 **

(0.231)0.572 **

(0.236)

0.433 77.0%

0.380

P
N
Log-Likelihood
R-squared

0.159 ***
643

643

643

-827.586-828.065-838.55079

0.218

0.217

0.191

(0.018)0.310(1) Significant at 1%(***), 5%(**), and 10%(*).
(2) The value in the dark black box shows the result in non-public utility industry and that in the light black box shows the result in public utility industry. The latter is calculated
as the sum of the coefficients of cross term and non-cross term of the same variable. [2015.6.29 1206]

19