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Rule Versus Discretion: Regulatory Uncertainty, Firm Investment, and the Ally Principle

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  • Montagnes, B, Pablo
  • Wolton, Stephane

Abstract

Previous studies of the bureaucracy have focused on the internal relationship between politicians (principals) and bureaucrats (agents). External regulated actors, such as firms, have generally been ignored. But firms strategically respond to their regulatory environment and regulatory uncertainty can deter investment. We examine how concerns about firms' strategic behavior affect the optimal internal organization of the bureaucracy. When regulatory uncertainty is about how much firms will be regulated, the ally principle applies: the principal delegates to an agent with similar preferences as hers. When regulatory uncertainty is about whether firms will be regulated, the ally principle fails to hold: the principal prefers an inefficient rule-based regulatory framework or, if possible, to delegate to an agent with preferences distinct from hers to encourage firm investment. We uncover novel endogenous limits to delegation since the principal faces a commitment problem not to replace a biased agent after the firm investment.

Suggested Citation

  • Montagnes, B, Pablo & Wolton, Stephane, 2015. "Rule Versus Discretion: Regulatory Uncertainty, Firm Investment, and the Ally Principle," MPRA Paper 65047, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:65047
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    File URL: https://mpra.ub.uni-muenchen.de/65047/1/MPRA_paper_65047.pdf
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    References listed on IDEAS

    as
    1. Susan Athey & Andrew Atkeson & Patrick J. Kehoe, 2005. "The Optimal Degree of Discretion in Monetary Policy," Econometrica, Econometric Society, vol. 73(5), pages 1431-1475, September.
    2. Sean Gailmard, 2002. "Expertise, Subversion, and Bureaucratic Discretion," Journal of Law, Economics, and Organization, Oxford University Press, vol. 18(2), pages 536-555, October.
    3. 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.
    4. Terry M. Moe, 2012. "Delegation, Control, and the Study of Public Bureaucracy," Introductory Chapters,in: Robert Gibbons & John Roberts (ed.), The Handbook of Organizational Economics Princeton University Press.
    5. repec:cup:apsrev:v:98:y:2004:i:02:p:293-310_00 is not listed on IDEAS
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    More about this item

    Keywords

    Regulatory Uncertainty; Ally Principle; Firm Investment;

    JEL classification:

    • D70 - Microeconomics - - Analysis of Collective Decision-Making - - - General
    • D73 - Microeconomics - - Analysis of Collective Decision-Making - - - Bureaucracy; Administrative Processes in Public Organizations; Corruption
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation

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