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Using Forward Contracts to Reduce Regulatory Capture

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  • Felix Höffler

    ()
    (Max Planck Institute for Research on Collective Goods, Bonn)

  • Sebastian Kranz

    ()
    (University of Bonn, Department of Economics)

Abstract

A fully unbundled, regulated network fi?rm of unknown efficiency level can undertake unobservable effort to increase the likelihood of low downstream prices, e.g., by facilitating downstream competition. To incentivize such effort, the regulator can use an incentive scheme paying transfers to the ?firm contingent on realized downstream prices. Alternatively, the regulator can propose to the ?firm to sell the following forward contracts: the fi?rm pays the downstream price to the owners of a contract, but receives the expected value of the contracts when selling them to a competitive fi?nancial market. We compare the two regulatory tools with respect to regulatory capture: if the regulator can be bribed to suppress information on the underlying state of the world (the basic probability of high downstream prices, or the type of the firm), optimal regulation uses forward contracts only.

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Bibliographic Info

Paper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2011_09.

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Date of creation: May 2011
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Handle: RePEc:mpg:wpaper:2011_09

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Keywords: Incentive regulation; regulatory capture; virtual power plants;

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  1. Matti Liski & Juan-Pablo Montero, 2005. "Forward trading and collusion in oligopoly," Working Papers 0506, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  2. Levine, Michael E & Forrence, Jennifer L, 1990. "Regulatory Capture, Public Interest, and the Public Agenda: Toward a Synthesis," Journal of Law, Economics and Organization, Oxford University Press, vol. 6(0), pages 167-98.
  3. Severin Borenstein & James. Bushnell & Steven Stoft, 2000. "The Competitive Effects of Transmission Capacity in A Deregulated Electricity Industry," RAND Journal of Economics, The RAND Corporation, vol. 31(2), pages 294-325, Summer.
  4. Loeb, Martin & Magat, Wesley A, 1979. "A Decentralized Method for Utility Regulation," Journal of Law and Economics, University of Chicago Press, vol. 22(2), pages 399-404, October.
  5. Fabra, Natalia & Toro, Juan, 2005. "Price wars and collusion in the Spanish electricity market," International Journal of Industrial Organization, Elsevier, vol. 23(3-4), pages 155-181, April.
  6. 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.
  7. Bushnell, James, 2007. "Oligopoly Equilibria in Electricity Contract Markets," Staff General Research Papers 13135, Iowa State University, Department of Economics.
  8. Christian Schultz, 2005. "Virtual Capacity and Competition," CESifo Working Paper Series 1487, CESifo Group Munich.
  9. Faure-Grimaud, Antoine, 2002. "Using Stock Price Information to Regulate Firms," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 169-90, January.
  10. Tirole, Jean, 1986. "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations," Journal of Law, Economics and Organization, Oxford University Press, vol. 2(2), pages 181-214, Fall.
  11. Allaz Blaise & Vila Jean-Luc, 1993. "Cournot Competition, Forward Markets and Efficiency," Journal of Economic Theory, Elsevier, vol. 59(1), pages 1-16, February.
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Cited by:
  1. Höffler, Felix & Wambach, Achim, 2013. "Investment Coordination in Network Industries: The Case of Electricity Grid and Electricity," EWI Working Papers 2013-12, Energiewirtschaftliches Institut an der Universitaet zu Koeln.
  2. Felix Höffler & Achim Wambach, 2013. "Investment coordination in network industries: the case of electricity grid and electricity generation," Journal of Regulatory Economics, Springer, vol. 44(3), pages 287-307, December.

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