In this paper we consider a regulated monopoly that can pad its costs to increase its cost reimbursement. Even while padding is ineácient the optimal incentive scheme tolerates some padding of costs to reduce the information rents paid to low cost types. It is shown that high cost firms pad costs more than low cost ßrms. We also show that cost padding moves pricing away from Ramsay optimal pricing toward more monopolistic pricing rules. We show that when auditing of total costs is costly, low cost firms face a fixed price contract and engage in no cost padding. High cost ßrms do less well but do engage in padding to increase the verified cost. If padded costs can be audited at some cost, low cost types engage in cost padding but high cost types do not. We also endogenize the distribution of cost types by allowing firms to engage in a pre-contractual, non-observable or verißable cost-reducing investment. The firm adopts a mixed strategy and this determines the distribution of cost types at the contracting stage. An example is given to show how the equilibrium distribution is computed.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Length: 33 pages Date of creation: Mar 2001 Date of revision:
Nov 2001 Publication status: Published in Handle: RePEc:kee:keeldp:2001/07
Contact details of provider: Postal: Department of Economics, University of Keele, Keele, Staffordshire, ST5 5BG - United Kingdom Phone: +44 (0)1782 584581 Fax: +44 (0)1782 717577 Email: Web page: http://www.keele.ac.uk/depts/ec/cer/ More information through EDIRC
Find related papers by JEL classification: D8 - Microeconomics - - Information, Knowledge, and Uncertainty L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior L5 - Industrial Organization - - Regulation and Industrial Policy
References listed on IDEAS 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.:
Did you know? Citation analysis on IDEAS includes online papers that are freely accessible and whose text could be automatically analyzed, currently about 150000 papers.