Deregulation, Uncertainty, and Information Technology in the Electric Utility Industry: A Transaction Cost Interpretation of the Drivers and Consequences of Vertical Disintegration

The choice of firm boundaries is one of the most fundamental elements of organizational strategy. It determines industry positioning, enables the development and leverage of distinctive capabilities, and ultimately establishes the basis for sustainable competitive advantage. In the modern economy, organizational unbundling and vertical disintegration has become a recurrent theme across many industries, reflecting a major transformation in industrial organization and firm strategy. What are the drivers of this modern trend of vertical disintegration? How do we reconcile this modern phenomenon with the vertical integration logic of previous decades? Beginning with Transaction Cost Economics (TCE) as the underlying framework, we draw from the Information Processing, Coordination and Capabilities literatures to develop an integrated theoretical framework for examining and rationalizing the determinants of vertical disintegration. The recent restructuring of the US electric utility industry provides a suitable empirical context to undertake a rigorous examination of this theoretical framework: a context that manifests institutional heterogeneity, high levels of uncertainty, intense coordination requirements, and a variety of competing market and organizational institutions in transition. We employ multi-level modeling techniques, to account for firm heterogeneity and time-variant institutional parameters in our longitudinal panel data, thus allowing for a richer analysis of institutional effects. The results show that there has been systematic vertical disintegration in the electric utility industry over the period of study, 1994-2002, influenced by both firm-level and state/federal-level institutional factors as well as structural market attributes, which serve as proxies for demand and supply uncertainty. Using IT investment intensity as a proxy for firm-level IT Capability, we also established an overall significant negative effect of IT on vertical integration, consistent with previous studies about the effects of IT on firm size. The main findings confirmed several standard TCE propositions, and also address several known shortcomings, most notably the ambiguity in the treatment of uncertainty. In addition, the robust examination of the empirical evidence associated with the restructuring of the Electric Utility industry allowed us to isolate the relative effects of various institutional mechanisms and structural market attributes. These findings help to illuminate the understanding and ultimately the programming of deregulation effects