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How to get firms to invest: A simple solution to the hold-up problem in regulation

Author

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  • Hans Gersbach

    () (Alfred-Weber-Institut, Universität Heidelberg, Grabengasse 14, 69117 Heidelberg, Germany)

Abstract

Many governmental programs are effective only if firms make costly investments. The inability of authorities to precommit to a regulatory scheme creates incentives for firms not to invest and to hold-up the regulator. This paper describes a simple subsidy/tax scheme embedded in a four-stage mechanism that solves the hold-up problem. We design a self-financing subsidy/tax scheme which benefits a complying firm at the expense of a non-complying firm. In order to be credible, the subsidy and tax rates must maximize social welfare for any combination of investment decisions. We show that there exists a unique subgame perfect equilibrium in which all firms invest and no actual implementation with subsidies and taxes is required. We discuss in which cases the mechanism can work under incomplete information.

Suggested Citation

  • Hans Gersbach, 2002. "How to get firms to invest: A simple solution to the hold-up problem in regulation," Review of Economic Design, Springer;Society for Economic Design, vol. 7(1), pages 45-56.
  • Handle: RePEc:spr:reecde:v:7:y:2002:i:1:p:45-56
    Note: Received: 30 December 1998 / Accepted: 12 October 2001
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    Citations

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    Cited by:

    1. Breitscheidel, Jörg, 2005. "Hold-up Problems with Respect to R&D Investment and Licensing in Environmental Regulation," ZEW Discussion Papers 05-86, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    2. Hans Gersbach & Till Requate, 2000. "Emission Taxes and the Design of Refunding Schemes," CESifo Working Paper Series 325, CESifo Group Munich.
    3. Lehmann, Paul, 2008. "Using a Policy Mix for Pollution Control – A Review of Economic Literature," MPRA Paper 21354, University Library of Munich, Germany.
    4. Sterner, Thomas & Muller, Adrian, 2006. "Output and Abatement Effects of Allocation Readjustment in Permit Trade," Discussion Papers dp-06-49, Resources For the Future.
    5. Joerg Breitscheidel & Hans Gersbach, 2005. "Self-Financing Environmental Mechanisms," CESifo Working Paper Series 1528, CESifo Group Munich.
    6. Puller, Steven L., 2006. "The strategic use of innovation to influence regulatory standards," Journal of Environmental Economics and Management, Elsevier, vol. 52(3), pages 690-706, November.
    7. Hans Gersbach, 2007. "The Global Refunding System and Climate Change," CER-ETH Economics working paper series 07/62, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
    8. Breitscheidel, Jörg, 2005. "Self-financing Tax/Subsidy Mechanisms in Environmental Regulation with Many Firms," ZEW Discussion Papers 05-87, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    9. Sterner, Thomas & Hoglund Isaksson, Lena, 2006. "Refunded emission payments theory, distribution of costs, and Swedish experience of NOx abatement," Ecological Economics, Elsevier, vol. 57(1), pages 93-106, April.

    More about this item

    Keywords

    Hold-up problem; environmental regulation; tax/subsidy mechanism; self-financing regulation;

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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