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The Optimal Regulation of a Risky Monopoly

Author

Listed:
  • Yolande Hiriart

    (Université de Bourgogne Franche-Comté, CRESE, IUF)

  • Lionel Thomas

    (Université de Bourgogne Franche-Comté, CRESE)

Abstract

We study the potential conflict between cost minimization and investment in prevention for a risky venture. A natural monopoly is regulated i) for economic purposes; ii) because it can cause losses of substantial size to third parties (the environment or people). The regulator observes the production cost without being able to distinguish the initial type (an adverse selection parameter) from the effort (a moral hazard variable). In addition, the investment in prevention is non observable (another moral hazard variable) and the monopoly is protected by limited liability. We fully characterize the optimal regulation in this context of asymmetric information plus limited liability. We show that incentives to reduce cost and to invest in safety are always compatible. But, in some cases, higher rents have to be given up by the regulator.

Suggested Citation

  • Yolande Hiriart & Lionel Thomas, 2015. "The Optimal Regulation of a Risky Monopoly," Working Papers 2015-16, CRESE.
    • Handle: RePEc:crb:wpaper:2015-16
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    References listed on IDEAS

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    1. Newman, Harry A. & Wright, David W., 1990. "Strict liability in a principal-agent model," International Review of Law and Economics, Elsevier, vol. 10(3), pages 219-231, December.
    2. Laffont, Jean-Jacques, 1995. "Regulation, moral hazard and insurance of environmental risks," Journal of Public Economics, Elsevier, vol. 58(3), pages 319-336, November.
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    5. Yolande Hiriart & David Martimort, 2006. "The benefits of extended liability," RAND Journal of Economics, RAND Corporation, vol. 37(3), pages 562-582, September.
    6. Baron, David P & Myerson, Roger B, 1982. "Regulating a Monopolist with Unknown Costs," Econometrica, Econometric Society, vol. 50(4), pages 911-930, July.
    7. Dieter Balkenborg, 2001. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment," American Economic Review, American Economic Association, vol. 91(3), pages 731-738, June.
    8. Boyer, Marcel & Laffont, Jean-Jacques, 1997. "Environmental risks and bank liability," European Economic Review, Elsevier, vol. 41(8), pages 1427-1459, August.
    9. Viscusi, W. Kip, 2007. "Regulation of Health, Safety, and Environmental Risks," Handbook of Law and Economics, in: A. Mitchell Polinsky & Steven Shavell (ed.), Handbook of Law and Economics, edition 1, volume 1, chapter 9, pages 591-645, Elsevier.
    10. Mark Bagnoli & Ted Bergstrom, 2006. "Log-concave probability and its applications," Studies in Economic Theory, in: Charalambos D. Aliprantis & Rosa L. Matzkin & Daniel L. McFadden & James C. Moore & Nicholas C. Yann (ed.), Rationality and Equilibrium, pages 217-241, Springer.
    11. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
    12. Hiriart, Yolande & Martimort, David, 2004. "Environmental Risk Regulation and Liability under Adverse Selection and Moral Hazard," IDEI Working Papers 256, Institut d'Économie Industrielle (IDEI), Toulouse.
    13. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
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    Cited by:

    1. Daiki Kishishita & Susumu Sato, 2021. "Optimal risk regulation of monopolists with subjective risk assessment," Journal of Regulatory Economics, Springer, vol. 59(3), pages 251-279, June.

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    More about this item

    Keywords

    Risk Regulation; Incentives; Moral Hazard; Adverse Selection; Insolvency;
    All these keywords.

    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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