Using the Latent Class Approach to Cluster Firms in Benchmarking: An Application to the US Electricity Transmission Industry

In this paper we advocate using the latent class model (LCM) approach to control for technological differences in traditional efficiency analysis of regulated electricity networks. Our proposal relies on the fact that latent class models are designed to cluster firms by uncovering differences in technology parameters. Moreover, it can be viewed as a supervised method for clustering data that takes into account the same (production or cost) relationship that is analysed later, often using nonparametric frontier techniques. The simulation exercises show that the proposed approach outperforms other sample selection procedures. The proposed methodology is illustrated with an application to a sample of US electricity transmission firms for the period 2001–2009.