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Dynamic Yardstick Regulation

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  • Faure-Grimaud, Antoine
  • Reiche, Sönje Kerrin
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    Abstract

    This Paper shows that the inability of regulators to commit to long-term contracts is irrelevant when there is some competition between regulated firms and when firms’ private information is correlated. This sharply contrasts with the dynamic of regulation without such competition. The Paper also explores what limitations on yardstick mechanisms can justify the use of long-term contracts. We found that the inability of a regulator to commit to not renegotiating long-term contracts is without consequences even if there is a bound on transfers that a firm can be asked to pay. In contrast, short-term contracting fails to implement the commitment solution with constraints on transfers. Second, absent current competition, the possibility of future entry allows the regulator to implement the first-best with a renegotiation-proof long-term contract whereas this cannot be achieved with short-term contracting.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4035.

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    Date of creation: Aug 2003
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    Handle: RePEc:cpr:ceprdp:4035

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    Related research

    Keywords: commitment; ratchet effect; short- and long-term contracts; yardstick regulation;

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    References

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    16. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-75, September.
    17. Robert, Jacques, 1991. "Continuity in auction design," Journal of Economic Theory, Elsevier, vol. 55(1), pages 169-179, October.
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    19. Dominique M. Demougin & Devon a. Garvie, 1991. "Contractual Design with Correlated Information Under Limited Liability," Working Papers 815, Queen's University, Department of Economics.
    20. Kumbhakar, Subal C. & Hjalmarsson, Lennart, 1998. "Relative performance of public and private ownership under yardstick competition: electricity retail distribution," European Economic Review, Elsevier, vol. 42(1), pages 97-122, January.
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