appeal to public interest arguments (such as cleaner air or construction job creation)
to justify receiving higher prices for their electricity. Merchant plants and other gen-
erators that rely heavily on the wholesale electricity market to recoup their pollution
control investments will be particularly reluctant to adopt a compliance strategy that
involves large investments in abatement equipment. Unlike utilities, many merchant
plants had low credit ratings in the years leading up to the SIP Call (Senate Com-
mittee on Energy and Natural Resources). Highly leveraged plants would have more
difficulties securing financing for major pollution control retrofits, which can cost over
$50M per unit.
The objective of this paper is to estimate a discrete choice model of firms’ com-
pliance decision in order to test the hypothesis that the type of electricity market in
which a coal plant is operating has significantly affected the environmental compli-
ance strategy choice. Using unique data on unit-level compliance costs, a conditional
logit model and a random parameter logit model of the compliance choice are esti-
mated. Results indicate that electricity market regulation significantly affected how
coal plants made their environmental compliance choices.
For decades, economists have studied the relationship between economic regula-
tion and the investment decisions of regulated firms. In their seminal paper, Averch
and Johnson demonstrate how rate of return regulation7 provides firms with an incen-
tive to overintensively substitute capital for other production factors. A large share
of the regulation literature has been devoted to extending and testing Averch and
Johnson’s work. Empirical verification of this effect in the context of the electric-
ity industry has been attempted several times with mixed results: Courville, Spann,
and Hayashi and Trapani all find support for the Averch-Johnson effect in the U.S.
electricity industry, whereas Boyes does not.
With the creation of the Acid Rain Program (ARP) in 1990, researchers became
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