Strategic choice of financing systems in regulated and interconnected industries

The growing importance of inter-network exchanges in infrastructure-based utilities influences regulatory choices and access pricing for downstream services using the infrastructures. We analyze this problem in a setting where the infrastructure managers of two bordering countries are in charge of pricing the access to their networks. The infrastructures are used by downstream firms to provide international services that link the two countries. Network costs can be financed either through a subsidy or solely through user charges. We first characterize the strategic interaction between infrastructure managers and show that it is affected by the regulatory modes adopted in the two countries. Then, we determine the equilibrium non-cooperative choice of a financing system. As opposed to the perfect cooperation benchmark, in which subsidizing the infrastructures is socially desirable, the commitment to strict budget-balance in both countries becomes socially preferable since this alleviates the externalities generated by non-coordination between access pricing decisions.