X-factor regulation in a developing country: The case of Lima's airport

In theory, X-factor regulation provides better incentives for cost reduction than previously widely-used rate-of-return regulation. However, a deeper look into how this factor is effectively estimated shows the regulator enjoys a great deal of discretion, especially when selecting the methodologies used to estimate its components. As shown in this paper, discretion increases the likelihood of controversies between the regulator and the regulated firm. This paper describes how the X-factor is estimated for Peruvian transport infrastructures and analyzes the most important controversies that arose when the X-factor for Lima's airport was estimated. Conclusions are the following: i) when the X-factor is estimated retrospectively careful planning is necessary since this option requires data that has to be collected at the time the infrastructure is concessioned; ii) cost of capital estimation is one of the main sources of controversy due to the subjective criteria used in its calculation and its impact in the final result; and, iii) transparent procedures improve the legitimacy of regulatory decisions, especially in contexts of limited public resources and weak institutions, typical of developing countries.