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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)

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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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Paper provided by EconWPA in its series Industrial Organization with number 0403002.

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Length: 40 pages
Date of creation: 03 Mar 2004
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Handle: RePEc:wpa:wuwpio:0403002

Note: Type of Document - pdf; pages: 40; figures: 3 figures, imported and attached at the end of the paper
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Related research
Keywords: public utilities price cap regulation profit-sharing stochastic games

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Find related papers by JEL classification:
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
L33 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Boundaries of Public and Private Enterprise; Privatization; Contracting Out
L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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