Regulating unverifiable quality by fixed-price contracts
AbstractWe apply the idea of relation contracting to a very simple problem of regulating a single-product monopolistic firm when the regulatory instrument is a fixed-price contract, and quality is endogenous and observable, but not verifiable. We model the interaction between the regulator and the firm as a dynamic game, and we show that, provided both players are sufficiently patient, there exist self-enforcing regula- tory contracts in which the firm prefers to produce the quality man- dated by the regulator, while the regulator chooses to leave the firm a positive rent as a reward to its quality choice. We also show that the socially optimal self-enforcing contract implies a distortion from the second best, which is greater the more impatient is the firm and the larger is the (marginal) effect of the contractual price on the profits the firm would make by deviating from the offered contract. Whenever the punishment profits are strictly positive, even if the firm were infinitely patient, the optimal contract would ensure a Ramsey condition but with positive profits to the firm. Our result also illustrates that, whenever the firm's output has some unverifiable component, optimal regulatory lag in fixed-price contract should be reduced to limit the reward of the firm's opportunistic behaviour.
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.
Bibliographic InfoPaper provided by THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise in its series THEMA Working Papers with number 2009-14.
Date of creation: 2009
Date of revision:
Contact details of provider:
Postal: 33, boulevard du port - 95011 Cergy-Pontoise Cedex
Phone: 33 1 34 25 60 63
Fax: 33 1 34 25 62 33
Web page: http://thema.u-cergy.fr
More information through EDIRC
Quality regulation; relational contracts;
Other versions of this item:
- Cesi Berardino & Iozzi Alberto & Valentini Edilio, 2012. "Regulating Unverifiable Quality by Fixed-Price Contracts," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 12(1), pages 1-39, September.
- L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
- L50 - Industrial Organization - - Regulation and Industrial Policy - - - General
You can help add them by filling out this form.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marion Oury).
If references are entirely missing, you can add them using this form.