Regulating Unverifiable Quality by Fixed-Price Contracts
We apply the idea of relational contracting to a simple problem of regulating a single-product monopoly with unverifiable (then ex ante not contractible) quality. We model the interaction between the regulator and the firm as an infinitely repeated game; we observe that there exist self-enforcing contracts in which the regulator, using her discretionary power on the price (the contractible variable) can induce the firm to produce the required quality level by leaving it a positive rent. When players use grim trigger strategies, the optimal self-enforcing contract implies a distortion from the second best which is greater the more impatient is the firm and the larger is the effect of the price on the deviation profits. Whenever the equilibrium profits of the static game are strictly positive, even if the firm were infinitely patient, the optimal contract would not reach the second-best: it would ensure a quality-adjusted Ramsey condition and, at the same time, leave positive profits to the firm. We extend the model in a few ways: we find that when players use stick-and-carrot strategies, with an infinitely patient firm the second-best outcome is reached even if this implies to punish the deviating firm with negative profits. When instead the regulator is unable to perfectly monitor the firm's quality choice, the price/quality pair giving the highest payoff to the regulator does not directly depend on the firm's discount factor, which instead affects the probability of punishment. Our results suggest that, in fixed price regulatory contracts, the regulatory lag should be shorter the more relevant is the issue of unverifiability, in order to reduce the reward for opportunistic behavior by the firm.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 12 (2012)
Issue (Month): 1 (September)
|Contact details of provider:|| Web page: http://www.degruyter.com|
|Order Information:||Web: http://www.degruyter.com/view/j/bejeap|
When requesting a correction, please mention this item's handle: RePEc:bpj:bejeap:v:12:y:2012:i:1:n:40. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Peter Golla)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.