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The Need for Regulating a Bayesian Regulator

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  • Semih Koray

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  • Ismail Saglam

Abstract

This paper analyzes the Baron and Myerson’s (B–M) (Econometrica 50: 911–930 [1982]) scheme of monopoly regulation, a standard representative of Bayesian mechanisms. As is well known, the hboxB–M mechanism (and other related mechanisms) have as an explicit starting point the assumption that the regulator has an unchallenged prior belief about the cost function of the regulated monopolist.We analyze here the consequences resulting from the possibility that this prior belief may be subject to influence or manipulable. As we show in detail, under the B–M scheme, consumers and the regulated monopoly are highly sensitive to the regulator’s prior belief about the (private) cost information of the monopolist. Therefore, if a regulator’s beliefs are unaccountable to and unverifiable by a higher ity, the regulator has both the incentive and the possibility to change and/or misrepresent his prior belief when facing pressure or payoffs from interest groups representing consumers or the regulated firm. The results here show that the outcomes under a B–M mechanism favoring one or another interest group can vary over a wide spectrum. The results are consistent with capture theory and rent-seeking explanations of monopoly regulation and suggest the need to exercise care in using the insights and results of Bayesian regulatory theory to inform practice. Copyright Springer Science+Business Media, Inc. 2005

Suggested Citation

  • Semih Koray & Ismail Saglam, 2005. "The Need for Regulating a Bayesian Regulator," Journal of Regulatory Economics, Springer, vol. 28(1), pages 5-21, July.
  • Handle: RePEc:kap:regeco:v:28:y:2005:i:1:p:5-21 DOI: 10.1007/s11149-005-2353-z
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    References listed on IDEAS

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    1. Koray, Semih & Sertel, Murat R., 1990. "Pretend-but-perform regulation and limit pricing," European Journal of Political Economy, Elsevier, vol. 6(4), pages 451-472.
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    4. Vogelsang, Ingo, 1988. "A Little Paradox in the Design of Regulatory Mechanisms," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(3), pages 467-476, August.
    5. Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January.
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    7. Crew, Michael A & Kleindorfer, Paul R, 2002. "Regulatory Economics: Twenty Years of Progress?," Journal of Regulatory Economics, Springer, vol. 21(1), pages 5-22, January.
    8. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
    9. James Hagerman, 1990. "Regulation by Price Adjustment," RAND Journal of Economics, The RAND Corporation, vol. 21(1), pages 72-82, Spring.
    10. Vogelsang, Ingo, 2002. "Incentive Regulation and Competition in Public Utility Markets: A 20-Year Perspective," Journal of Regulatory Economics, Springer, vol. 22(1), pages 5-27, July.
    11. Lyon, Thomas P, 1996. "Evaluating the Performance of Non-Bayesian Regulatory Mechanisms," Journal of Regulatory Economics, Springer, vol. 9(1), pages 41-60, January.
    12. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
    13. Gibbard, Allan, 1973. "Manipulation of Voting Schemes: A General Result," Econometrica, Econometric Society, vol. 41(4), pages 587-601, July.
    14. Koray, Semih & Saglam, Ismail, 2005. "Learning in Bayesian Regulation," MPRA Paper 1899, University Library of Munich, Germany.
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    Cited by:

    1. repec:ebl:ecbull:v:3:y:2007:i:12:p:1-10 is not listed on IDEAS
    2. Corchón, Luis C., 2008. "The theory of implementation : what did we learn?," UC3M Working papers. Economics we081207, Universidad Carlos III de Madrid. Departamento de Economía.
    3. Gustavo Ferro & Omar Chisari, 2010. "Tópicos de Economía de la Regulación de los Servicios Públicos," Working Papers hal-00473038, HAL.
    4. Ingo Vogelsang, 2006. "Electricity Transmission Pricing and Performance-based Regulation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 97-126.
    5. Flavio M. Menezes & Christian Roessler, 2010. "Good and Bad Consistency in Regulatory Decisions," The Economic Record, The Economic Society of Australia, vol. 86(275), pages 504-516, December.
    6. Ismail Saglam & Semih Koray, 2007. "Learning in Bayesian regulation: desirable or undesirable?," Economics Bulletin, AccessEcon, vol. 3(12), pages 1-10.
    7. Koray, Semih & Saglam, Ismail, 2005. "Learning in Bayesian Regulation," MPRA Paper 1899, University Library of Munich, Germany.
    8. Mohammad Reza Hesamzadeh & Juan Rosellón & Steven A. Gabriel & Ingo Vogelsang, 2017. "A Simple Regulatory Incentive Mechanism Applied to Electricity Transmission Pricing and Investment," Discussion Papers of DIW Berlin 1696, DIW Berlin, German Institute for Economic Research.
    9. Ismail Saglam, 2016. "On the Pareto Efficiency of a Socially Optimal Mechanism for Monopoly Regulation," IPEK Working Papers 1601, Ipek University, Department of Economics, revised May 2016.
    10. Saglam, Ismail, 2014. "Research and Development of an Optimally Regulated Monopolist with Unknown Costs," MPRA Paper 60245, University Library of Munich, Germany.

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