Dynamic Regulation Design Without Payments: Timing is Everything
We consider a two period model of optimal regulation of a ﬁrm subject to marginal compliance cost shocks. The regulator faces an asymmetric information problem: the ﬁrm knows current compliance costs, but the regulator does not. Both the regulator and the ﬁrm are uncertain about future costs. In our basic framework, the regulator may not oﬀer payments to the ﬁrm; we show that the regulator can vary the strength of regulation over time to induce the ﬁrm to reveal its costs and increase welfare. In the optimal mechanism, the regulator oﬀers stronger (weaker) regulation in the ﬁrst period and weaker (stronger) regulation in the second period if the ﬁrm reports low (high) compliance costs in the ﬁrst period. Low cost ﬁrms expect compliance costs to rise in the future, and thus prefer weaker regulation in the second period. High cost ﬁrms expect costs to fall in the future and thus prefer regulation which becomes more strict over time. Thus the regulator oﬀers the low (high) cost ﬁrms slightly weaker (stronger) regulation in the second period in exchange for much stronger (weaker) regulation in the ﬁrst period. We refer to our dynamic mechanism as “timing” the regulation. If the regulator can make payments, then the optimal mechanism to some degree times the regulation as long as a positive cost of funds exists. If the cost of funds is high enough, then under the optimal mechanism the regulator will not use payments and only use our timing mechanism
|Date of creation:||2011|
|Date of revision:|
|Publication status:||Forthcoming: Working|
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