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Regulatory Holidays and Optimal Network Expansion

Author

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  • Willems, Bert

    (Tilburg University, TILEC)

  • Zwart, Gijsbert

    (Tilburg University, TILEC)

Abstract

We model the optimal regulation of continuous, irreversible, capacity expansion, in a model in which the regulated network firm has private information about its capacity costs, investments need to be financed out of the firm’s cash flows from selling network access and demand is stochastic. If asymmetric information is large, the optimal mechanism consists of a regulatory holiday for low-cost firms, and a mark-up regime for higher-cost rms. With the regulatory holiday, a firm receives the full revenue of capacity sales, and expands capacity as if it were an unregulated monopolist. Under the mark-up regime, a firm receives only a fraction of the capacity revenues, and is obliged to expand capacity whenever the price for capacity reaches a threshold. The regulatory holiday is necessary to fund information rents to the most efficient firms, which invest relatively early, as direct investment subsidies are not feasible.
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Suggested Citation

  • Willems, Bert & Zwart, Gijsbert, 2016. "Regulatory Holidays and Optimal Network Expansion," Discussion Paper 2016-008, Tilburg University, Tilburg Law and Economic Center.
    • Handle: RePEc:tiu:tiutil:27b0bab0-e60a-4682-aec0-1ba4fdad66a5
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    References listed on IDEAS

    as
    1. Peter Broer & Gijsbert Zwart, 2013. "Optimal regulation of lumpy investments," Journal of Regulatory Economics, Springer, vol. 44(2), pages 177-196, October.
    2. Armstrong, Mark & Sappington, David E.M., 2007. "Recent Developments in the Theory of Regulation," Handbook of Industrial Organization, in: Mark Armstrong & Robert Porter (ed.), Handbook of Industrial Organization, edition 1, volume 3, chapter 27, pages 1557-1700, Elsevier.
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    More about this item

    Keywords

    egulatory holiday; real option value; asymmetric information; optimal contract;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L52 - Industrial Organization - - Regulation and Industrial Policy - - - Industrial Policy; Sectoral Planning Methods

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