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Regulatory risk, vertical integration, and upstream investment

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  • Fiocco, Raffaele
  • Guo, Dongyu

Abstract

We investigate the impact of regulatory risk on vertical integration and upstream investment by a regulated firm that provides an essential input to downstream competitors. Regulatory risk reflects uncertainty about the regulator’s commitment to a regulatory policy that promotes the regulated firm’s noncontractible investment. We show that, when the regulator sets the regulatory policy after the vertical industry structure has been established, some degree of regulatory risk is ex ante socially beneficial. Regulatory risk makes vertical integration profitable and stimulates high upstream investment at a lower social cost. This occurs for moderate costs of high investment and firms’ small risk aversion. Our analysis sheds new light on some relevant empirical patterns in vertically related markets.

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  • Fiocco, Raffaele & Guo, Dongyu, 2020. "Regulatory risk, vertical integration, and upstream investment," European Economic Review, Elsevier, vol. 128(C).
    • Handle: RePEc:eee:eecrev:v:128:y:2020:i:c:s0014292120301458
    DOI: 10.1016/j.euroecorev.2020.103514
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    More about this item

    Keywords

    Commitment; Moral hazard; Regulatory risk; Upstream investment; Vertical integration; Vertically related markets;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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