Cost padding in regulated monopolies
AbstractThis paper considers the regulated monopoly that pads or falsifies its costs to increase the cost reimbursement it receives from the regulator. Contrary to the standard literature on cost regulation, the firm engages in cost reducing investment before it enters into a regulatory contract. This pre-contractual investment in cost reduction determines the firm type at the contracting stage. The paper derives both the optimum incentive compatible falsification contract and the equilibrium type distribution. With the distribution of cost types determined endogenously by the pre-contractual investment choice, an increase in the cost of falsification has two effects. First, there is a direct effect that reduces cost padding because it becomes more expensive to do so. Second, there is an indirect effect that increases cost padding because the firm responds by choosing lower investments, and lower investments are associated with more cost padding. It is demonstrated that the direct effect will dominate and both expected levels of cost padding and expected costs for falsification will be reduced. However, the indirect effect increases real costs and, despite the reduction in cost padding, the net effect can reduce welfare. It is determined that these conclusions are significantly different from those obtained when the distribution of cost types is exogenously fixed.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Elsevier in its journal International Journal of Industrial Organization.
Volume (Year): 30 (2012)
Issue (Month): 4 ()
Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/505551
Cost padding; Costly state falsification; Endogenous screening;
Other versions of this item:
- Spiros Bougheas & Tim Worrall, 2001. "Cost Padding in Regulated Monopolies," Keele Department of Economics Discussion Papers (1995-2001) 2001/07, Department of Economics, Keele University, revised Nov 2001.
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation
- L52 - Industrial Organization - - Regulation and Industrial Policy - - - Industrial Policy; Sectoral Planning Methods
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
- Gul, Faruk, 2001.
"Unobservable Investment and the Hold-Up Problem,"
Econometric Society, vol. 69(2), pages 343-76, March.
- Laffont, Jean-Jacques & Tirole, Jean, 1986.
"Using Cost Observation to Regulate Firms,"
Journal of Political Economy,
University of Chicago Press, vol. 94(3), pages 614-41, June.
- David P. Baron & Roger B. Myerson, 1979.
"Regulating a Monopolist with Unknown Costs,"
412, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Lacker, Jeffrey M & Weinberg, John A, 1989.
"Optimal Contracts under Costly State Falsification,"
Journal of Political Economy,
University of Chicago Press, vol. 97(6), pages 1345-63, December.
- Lacker, J.M., 1989. "Optimal Contracts Under Costly State Falsification," Purdue University Economics Working Papers 956, Purdue University, Department of Economics.
- Michael D. Grubb, 2006.
"Selling to Overconfident Consumers,"
06-018, Stanford Institute for Economic Policy Research.
- Albon, Robert P & Kirby, Michael G, 1983. "Cost-Padding in Profit-Regulated Firms," The Economic Record, The Economic Society of Australia, vol. 59(164), pages 16-27, March.
- Gonzalez, Patrick, 2002.
"Investment and Screening under Asymmetric Endogenous Information,"
Cahiers de recherche
- Patrick Gonz�lez, 2004. "Investment and Screening Under Asymmetric Endogenous Information," RAND Journal of Economics, The RAND Corporation, vol. 35(3), pages 502-519, Autumn.
- Gonz�lez, Patrick, 2002. "Investment and Screening under Asymmetric Endogenous Information," Cahiers de recherche 0204, Université Laval - Département d'économique.
- Keith J. Crocker & John Morgan, 1998. "Is Honesty the Best Policy? Curtailing Insurance Fraud through Optimal Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 355-375, April.
- Rauf Gönenç & Maria Maher & Giuseppe Nicoletti, 2000.
"The Implementation and the Effects of Regulatory Reform: Past Experience and Current Issues,"
OECD Economics Department Working Papers
251, OECD Publishing.
- Rauf Gönenç & Maria Maher & Giuseppe Nicoletti, 2001. "The Implementation and the Effects of Regulatory Reform: Past Experience and Current Issues," OECD Economic Studies, OECD Publishing, vol. 2001(1), pages 11-98.
- Ilya Segal & Michael D. Whinston, 2002. "The Mirrlees Approach to Mechanism Design with Renegotiation (with Applications to Hold-up and Risk Sharing)," Econometrica, Econometric Society, vol. 70(1), pages 1-45, January.
- Giovanni Maggi & Andres Rodriguez-Clare, 1995. "Costly Distortion of Information in Agency Problems," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 675-689, Winter.
- Laffont, Jean-Jacques, 1992.
"The New Economics of Regulation Ten Years After,"
IDEI Working Papers
22, Institut d'Économie Industrielle (IDEI), Toulouse.
- Monteiro, Paulo Klinger & Svaiter, Benar Fux, 2010.
"Optimal auction with a general distribution: Virtual valuation without densities,"
Journal of Mathematical Economics,
Elsevier, vol. 46(1), pages 21-31, January.
- Svaiter, Benar Fux & Monteiro, Paulo Klinger, 2008. "Optimal auction with a general distribution: virtual valuation without densities," Economics Working Papers (Ensaios Economicos da EPGE) 681, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- Martin F. Hellwig, 2010.
"Incentive Problems With Unidimensional Hidden Characteristics: A Unified Approach,"
Econometric Society, vol. 78(4), pages 1201-1237, 07.
- Martin Hellwig, 2006. "Incentive Problems with Unidimensional Hidden Characteristics: A Unified Approach," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2006_26, Max Planck Institute for Research on Collective Goods, revised Apr 2010.
- Daughety, Andrew F, 1984. "Regulation and Industrial Organization," Journal of Political Economy, University of Chicago Press, vol. 92(5), pages 932-53, October.
- Garret Kent Fellows, 2014. "Capital Input Decisions under Rate of Return Regulation," Working Papers 2014-37, Department of Economics, University of Calgary, revised 10 Feb 2014.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.