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Price Regulation, Investment and the Commitment Problem

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Author Info

  • Paul Levine

    (University of Surrey and LBS)

  • Neil Rickman

    (University of Surrey and CEPR)

Abstract

We consider a dynamic model of price regulation with asymmetric information where strategic delegation is available to the regulator. Firms can sink non-contractible, cost-reducing investment but regulators cannot commit to future price levels. We fully characterise the perfect Bayesian equilibrium and show that, with incentive contracts and no delegation, under-investment occurs. We then show that delegation to a suitable regulator can both improve investment incentives and ameliorate the ratchet effect by credibly offering the firm future rent. Simulations indicate significant welfare gains from these two effects and that a wide range of regulatory preferences can achieve this result.

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File URL: http://www.fahs.surrey.ac.uk/economics/discussion_papers/2003/DP06-03.pdf
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Bibliographic Info

Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0603.

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Length: 35 pages
Date of creation: May 2003
Date of revision:
Handle: RePEc:sur:surrec:0603

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Postal: Guildford, Surrey GU2 5XH
Phone: (01483) 259380
Fax: (01483) 259548
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Web page: http://www.surrey.ac.uk/economics/
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Related research

Keywords: under-investment; commitment; price regulation;

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References

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  1. Currie, David & Levine, Paul L & Rickman, Neil, 1999. "Delegation and the Ratchet Effect: Should Regulators Be Pro-Industry?," CEPR Discussion Papers 2274, C.E.P.R. Discussion Papers.
  2. Goodwin, Thomas H. & Patrick, Robert H., 1992. "Capital recovery for the regulated firm under certainty and regulatory uncertainty," Resources and Energy, Elsevier, vol. 14(4), pages 337-361, December.
  3. Fershtman, C. & Gneezy, U., 1997. "Strategic delegation: An experiment," Discussion Paper 1997-26, Tilburg University, Center for Economic Research.
  4. Fershtman, Chaim & Judd, Kenneth L & Kalai, Ehud, 1991. "Observable Contracts: Strategic Delegation and Cooperation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 551-59, August.
  5. Dalen, Dag Morten, 1995. "Efficiency-improving investment and the ratchet effect," European Economic Review, Elsevier, vol. 39(8), pages 1511-1522, October.
  6. Urbiztondo, Santiago, 1994. "Investment without Regulatory Commitment: The Case of Elastic Demand," Journal of Regulatory Economics, Springer, vol. 6(1), pages 87-96, February.
  7. Fershtman, C. & Kalai, E., 1993. "Unobserved Delegation," Papers 10-93, Tel Aviv - the Sackler Institute of Economic Studies.
    • Fershtman, Chaim & Kalai, Ehud, 1997. "Unobserved Delegation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(4), pages 763-74, November.
  8. Lyon, T.P., 1993. "Regulatory Hindsight Review and Innovation by Electric Utilities," Papers 93-013, Indiana - Center for Econometric Model Research.
  9. Lewis, T.R. & Sappington, D.E.M., 1988. "Oversight Of Long-Term Investment By Short-Lived Regulators," Papers 325, California Davis - Institute of Governmental Affairs.
  10. David M. Newbery, 2002. "Privatization, Restructuring, and Regulation of Network Utilities," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262640481, December.
  11. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  12. Spulber, Daniel F & Besanko, David, 1992. "Delegation, Commitment, and the Regulatory Mandate," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(1), pages 126-54, March.
  13. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, December.
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Citations

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Cited by:
  1. Maiorano, F. & Stern, J., 2007. "Institutions and investment in low and middle-income countries: the case of mobile communications," Working Papers 07/06, Department of Economics, City University London.
  2. Brito Duarte & Pereira Pedro & Vareda João, 2013. "Investment, Dynamic Consistency and the Sectoral Regulator’s Objective," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 13(2), pages 563-594, August.
  3. Paul Levine & Paul Levine & Jon Stern & Francesc Trillas, 2003. "Independent Utility Regulators: Lessons from Monetary Policy," School of Economics Discussion Papers 0403, School of Economics, University of Surrey.
  4. Paul Levine & Neil Rickman & Francesc Trillas, 2006. "Price Regulation and the Commitment Problem: Can Limited Capture be Beneficial?," School of Economics Discussion Papers 0106, School of Economics, University of Surrey.
  5. Joanne Evans & Paul Levine & Fransesc Trillas, 2006. "Lobbies, Delegation and the Under-investment Problem in Regulation," School of Economics Discussion Papers 2006, School of Economics, University of Surrey.
  6. Antonio Estache & L. Wren-Lewis, 2008. "Towards a Theory of Regulation for Developing Countries: Following Laffont's Lead," Working Papers ECARES 2008_018, ULB -- Universite Libre de Bruxelles.

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