In 2009, Detroit Michigan experienced an aggressive recession compared to the rest of country. With unemployment rates topping 15%, the city was faced many challenges financially, economically and socially. In addition to the financial challenges, the city was also experiencing political instability and corruption. The major and various city officials were being investigated for fraud, bribery and other criminal charges.
Spirit Electric, operating as a natural monopoly, was the only company in the area to provide electric serves to the households. Like many other companies, it was experiencing financial difficulties and could no longer continue without some intervention. This was mainly due to high operating costs, foreclosures in the area and the fact that many households were not paying their bills. As a result, Spirit Electric came to a standstill in the latter part of 2009.
Matt Green, Spirit electric CEO gathered the Board of Directors and determined that the company would need to take some sort of course of action in order to remain functioning. Matt Green outlined 4 proposals and urged each board member to vote accordingly, providing justification to their proposal.
Proposal One: Ask the government for a bailout of $30 Million dollars to allow Spirit Electric to continue operating. Pay back will be at 15% within 5 years.
Proposal Two: Allow two other additional Electric companies to join the industry and supply electric to the people of Detroit. The companies would be competing against one another and households would have a choice in choosing which company they would like.
Proposal Three: Increase electric rates in the short term for all users. Once the economy regains, electric rates return to normal
Proposal Four: Create private ‘virtual’ accounts managed by Spirit Electric for all households. These accounts would allow households who fall behind to ‘credit’ their account with a 2% fee after 6 months of not paying
1. Which of these proposals is the most efficient for the city of Detroit? Why is it more efficient than the other three?
2. Is competition needed in this situation? How does competition alter the dynamics of city? Household?
3. Taking into account that Spirit Electric is operating as a natural monopoly, what should be its goal? How should it determine its price?
4. How should you forecast the outcome for Spirit Electric?
5. What are the different types of risk involved in your chosen proposal?
6. What types of costs should be considered in your chosen proposal?
7. Did a principal/agent problem occur in this situation? How can it be avoided moving forward?