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The Effect of Awareness and Observability on the Non-contractible Investment of a Regulated Natural Monopoly

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  • Ismail Saglam

    (TOBB University of Economics and Technology)

Abstract

This paper studies the joint effect of the regulator’s ex-ante awareness and ex-post ability to observe on the non-contractible investment activities of a natural monopoly with private marginal cost information. We show that the investment activities are lower when the regulator is ex-ante aware of their existence and ex-post able to observe them than when the regulator is never aware of, and never able to observe, them. This result, which points to the regulated firm’s prevention of ratcheting, is in line with an earlier finding of Tirole (J Polit Econ 94:235–259 1986) obtained in a bargaining model of procurement with two-sided asymmetric information. We also find that the producer welfare and the social surplus is always ex-ante higher when the regulator is unaware of its investment activities than when she is aware. Moreover, our computations show that depending on the specifications of our model, the unawareness of the regulator may positively affect the expected consumer and social welfares, as well.

Suggested Citation

  • Ismail Saglam, 2019. "The Effect of Awareness and Observability on the Non-contractible Investment of a Regulated Natural Monopoly," Journal of Industry, Competition and Trade, Springer, vol. 19(4), pages 617-639, December.
    • Handle: RePEc:kap:jincot:v:19:y:2019:i:4:d:10.1007_s10842-019-00306-3
    DOI: 10.1007/s10842-019-00306-3
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    References listed on IDEAS

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    1. Gul, Faruk, 2001. "Unobservable Investment and the Hold-Up Problem," Econometrica, Econometric Society, vol. 69(2), pages 343-376, March.
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    5. Benjamin E. Hermalin & Michael L. Katz, 2009. "Information and the hold‐up problem," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 405-423, September.
    6. Dezsö Szalay, 2005. "The Economics of Clear Advice and Extreme Options," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(4), pages 1173-1198.
    7. Randolph Sloof & Hessel Oosterbeek & Joep Sonnemans, 2007. "Does Making Specific Investments Unobservable Boost Investment Incentives?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 16(4), pages 911-942, December.
    8. 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.
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    10. Tirole, Jean, 1986. "Procurement and Renegotiation," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 235-259, April.
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    Cited by:

    1. Ismail Saglam, 2023. "Incentives of a monopolist for innovation under regulatory threat," Economics of Governance, Springer, vol. 24(1), pages 41-66, March.

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    More about this item

    Keywords

    Monopoly; Regulation; Investment; Awareness; Observability; Asymmetric information;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • O32 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Management of Technological Innovation and R&D

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