AN EQUIVALENCE EXISTS between (1) damages for breach of the regulatory contract; (2) just compensation for a regulatory taking; (3) the change in investor valuation of the utility after deregulation; and (4) pricing policies that promote efficient entry and interconnection in network industries opened to competition by using the incumbent's facilities. Those identities constitute the equivalence principle.

In this chapter we set out the equivalence principle within the context of the basic deregulation model. The equivalence translates readily to a multiperiod setting where the firm's opportunity cost is the difference between the present discounted value of regulatory returns and the present discounted value of competitive returns, where each stream of returns is discounted at the rate appropriate for the riskiness of the stream of returns.

The common thread is the interplay between economic expectations and opportunity costs. Economic agents make choices by comparing the expected net benefits of available alternatives. All economic choices are “forward looking,” with the preferred choice yielding the greatest expected benefits. The opportunity cost of the preferred choice is the value of the best alternative. By definition, the expected benefits of the preferred choice exceed its opportunity cost. Although we focus on transitional remedies for unexpected deregulation, the equivalence principle applies equally to remedies for breach of private contract and property protections for competitive firms.

The equivalence principle establishes that the compensation of regulated firms when making the transition to a competitive market can be calculated by using either a contract damages approach or a property compensation approach. Moreover, the financial valuation approach that the firm uses provides another forward-looking measure for determining the expected effects of deregulation.