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Opting-out in profit-sharing regulation

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Author Info

  • Michele Moretto

    (University of Brescia)

  • Paola Valbonesi

    (University of Padova)

Abstract

To avoid the extremely high profit levels found in recent experiences with price cap regulation, some regulators have proposed a profit-sharing mechanism that revises prices to the benefit of consumers. This paper investigates the conditions under which a regulator can implement such a profit-sharing scheme, having the option to revoke the contract if the firm's profits are excessive. When this option is included in the regulator's objective function and the cost of exercising it is not too high, a long-term equilibrium arises with a state-contingent sharing rule that guarantees and appropriate level of profits. The model determines both the level of profits that triggers the profit- sharing mechanism and the consequent price adjustment endogenously. There is an endogenous regulatory lag initially characterized by a price cap regulation, followed by a period of profit-sharing regime where the firm is motivated to cut prices to avoid revocation.

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File URL: http://128.118.178.162/eps/io/papers/0403/0403001.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Industrial Organization with number 0403001.

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Length: 40 pages
Date of creation: 02 Mar 2004
Date of revision:
Handle: RePEc:wpa:wuwpio:0403001

Note: Type of Document - pdf; pages: 40
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Web page: http://128.118.178.162

Related research

Keywords: Public utilities; Price cap regulation; profit-sharing; stochastic games;

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References

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  1. Michele Moretto & Paolo M. Panteghini & Carlo Scarpa, 2003. "Investment Size and Firm’s Value Under Profit Sharing Regulation," Working Papers 2003.80, Fondazione Eni Enrico Mattei.
  2. Lucy Chennells, 1997. "The windfall tax," Fiscal Studies, Institute for Fiscal Studies, vol. 18(3), pages 279-291, August.
  3. Amrstong, Mark & Cowan, Simon & Vickers, John, 1995. "Nonlinear pricing and price cap regulation," Journal of Public Economics, Elsevier, vol. 58(1), pages 33-55, September.
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  13. Crew, Michael A & Kleindorfer, Paul R, 1996. "Incentive Regulation in the United Kingdom and the United States: Some Lessons," Journal of Regulatory Economics, Springer, vol. 9(3), pages 211-25, May.
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  16. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
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  18. Paul L. Joskow, 2006. "Incentive Regulation for Electricity Networks," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 4(2), pages 3-9, 07.
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