Factors Affecting Inefficiency Level: Stochastic Frontier Analysis of Public Utility Firms in Japan

The main purpose of this study is to investigate what types of internal and external factors affect technical inefficiency in public utility firms. We consider governance structure and business diversification strategy as internal factors and governmental intervention and competition as external factors. By using 1106 observations comprised of Japanese public utility firms from 1989 to 2002, we estimate the stochastic frontier production function. The main findings are as follows: (i) The governance factor has an important effect on a firm’s inefficiency. As ownership by foreign shareholders and investment funds increase, the technical inefficiency of a public utility firm decreases. (ii) A business diversification strategy increases inefficiency, though the magnitude of increase is relatively small. (iii) Governmental intervention does not have a clear effect on inefficiency. (iv) The monopoly level shows a quite clear effect on a firm’s inefficiency. Overall, our empirical results suggest that internal factors such as governance structure and ownership by foreign shareholders and investment funds, and external factors such as monopoly level are factors especially important to the reduction of technical inefficiency in public utilities.