Cost Padding in Regulated Monopolies
In this paper we consider a regulated monopoly that can pad its costs to increase its cost reimbursement. Even while padding is ineácient the optimal incentive scheme tolerates some padding of costs to reduce the information rents paid to low cost types. It is shown that high cost firms pad costs more than low cost ßrms. We also show that cost padding moves pricing away from Ramsay optimal pricing toward more monopolistic pricing rules. We show that when auditing of total costs is costly, low cost firms face a fixed price contract and engage in no cost padding. High cost ßrms do less well but do engage in padding to increase the verified cost. If padded costs can be audited at some cost, low cost types engage in cost padding but high cost types do not. We also endogenize the distribution of cost types by allowing firms to engage in a pre-contractual, non-observable or verißable cost-reducing investment. The firm adopts a mixed strategy and this determines the distribution of cost types at the contracting stage. An example is given to show how the equilibrium distribution is computed.
|Date of creation:||Mar 2001|
|Date of revision:||Nov 2001|
|Publication status:||Published in|
|Contact details of provider:|| Postal: Department of Economics, University of Keele, Keele, Staffordshire, ST5 5BG - United Kingdom|
Phone: +44 (0)1782 584581
Fax: +44 (0)1782 717577
Web page: http://www.keele.ac.uk/depts/ec/cer/
More information through EDIRC
|Order Information:|| Postal: Department of Economics, Keele University, Keele, Staffordshire ST5 5BG - United Kingdom|
Web: http://www.keele.ac.uk/depts/ec/cer/pubs_kerps.htm Email:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Michael D. Grubb, 2009.
"Selling to Overconfident Consumers,"
American Economic Review,
American Economic Association, vol. 99(5), pages 1770-1807, December.
- Baron, David P & Myerson, Roger B, 1982.
"Regulating a Monopolist with Unknown Costs,"
Econometric Society, vol. 50(4), pages 911-30, July.
- F. Gul, 2000.
"Unobservable Investment and the Hold-Up Problem,"
Princeton Economic Theory Papers
00s10, Economics Department, Princeton University.
- Keith J. Crocker & John Morgan, 1998. "Is Honesty the Best Policy? Curtailing Insurance Fraud through Optimal Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 355-375, April.
- Daughety, Andrew F, 1984. "Regulation and Industrial Organization," Journal of Political Economy, University of Chicago Press, vol. 92(5), pages 932-53, October.
- Patrick Gonzàlez, 2004.
"Investment and Screening Under Asymmetric Endogenous Information,"
RAND Journal of Economics,
The RAND Corporation, vol. 35(3), pages 502-519, Autumn.
- Gonzalez, Patrick, 2002. "Investment and Screening under Asymmetric Endogenous Information," Cahiers de recherche 0201, GREEN.
- González, Patrick, 2002. "Investment and Screening under Asymmetric Endogenous Information," Cahiers de recherche 0204, Université Laval - Département d'économique.
- Martin Hellwig, 2006.
"Incentive Problems with Unidimensional Hidden Characteristics: A Unified Approach,"
Working Paper Series of the Max Planck Institute for Research on Collective Goods
2006_26, Max Planck Institute for Research on Collective Goods, revised Apr 2010.
- Martin F. Hellwig, 2010. "Incentive Problems With Unidimensional Hidden Characteristics: A Unified Approach," Econometrica, Econometric Society, vol. 78(4), pages 1201-1237, 07.
- Laffont, Jean-Jacques, 1992.
"The New Economics of Regulation Ten Years After,"
IDEI Working Papers
22, Institut d'Économie Industrielle (IDEI), Toulouse.
- Rauf GÃ¶nenÃ§ & Maria Maher & Giuseppe Nicoletti, 2003.
"The Implementation and the Effects of Regulatory Reform: Past Experience and Current Issues,"
OECD Economic Studies,
OECD Publishing, vol. 2001(1), pages 11-98.
- Rauf GÃ¶nenÃ§ & Maria Maher & Giuseppe Nicoletti, 2000. "The Implementation and the Effects of Regulatory Reform: Past Experience and Current Issues," OECD Economics Department Working Papers 251, OECD Publishing.
- Monteiro, Paulo Klinger & Svaiter, Benar Fux, 2010.
"Optimal auction with a general distribution: Virtual valuation without densities,"
Journal of Mathematical Economics,
Elsevier, vol. 46(1), pages 21-31, January.
- Svaiter, Benar Fux & Monteiro, P. K., 2008. "Optimal auction with a general distribution: virtual valuation without densities," Economics Working Papers (Ensaios Economicos da EPGE) 681, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
- Jean Tirole & Jean-Jaques Laffont, 1985.
"Using Cost Observation to Regulate Firms,"
368, Massachusetts Institute of Technology (MIT), Department of Economics.
- Albon, Robert P & Kirby, Michael G, 1983. "Cost-Padding in Profit-Regulated Firms," The Economic Record, The Economic Society of Australia, vol. 59(164), pages 16-27, March.
- Giovanni Maggi & Andres Rodriguez-Clare, 1995. "Costly Distortion of Information in Agency Problems," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 675-689, Winter.
- 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, March.
- Ilya Segal & Michael D. Whinston, 2002. "The Mirrlees Approach to Mechanism Design with Renegotiation (with Applications to Hold-up and Risk Sharing)," Econometrica, Econometric Society, vol. 70(1), pages 1-45, January.
- Lacker, J.M., 1989.
"Optimal Contracts Under Costly State Falsification,"
Purdue University Economics Working Papers
956, Purdue University, Department of Economics.
- Lacker, Jeffrey M & Weinberg, John A, 1989. "Optimal Contracts under Costly State Falsification," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1345-63, December.
When requesting a correction, please mention this item's handle: RePEc:kee:keeldp:2001/07. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Martin E. Diedrich)
If references are entirely missing, you can add them using this form.