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Price Regulation, Investment and the Commitment Problem

  • Paul Levine

    (University of Surrey and LBS)

  • Neil Rickman

    (University of Surrey and CEPR)

We consider a dynamic model of price regulation with asymmetric information where strategic delegation is available to the regulator. Firms can sink non-contractible, cost-reducing investment but regulators cannot commit to future price levels. We fully characterise the perfect Bayesian equilibrium and show that, with incentive contracts and no delegation, under-investment occurs. We then show that delegation to a suitable regulator can both improve investment incentives and ameliorate the ratchet effect by credibly offering the firm future rent. Simulations indicate significant welfare gains from these two effects and that a wide range of regulatory preferences can achieve this result.

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Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0603.

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Length: 35 pages
Date of creation: May 2003
Date of revision:
Handle: RePEc:sur:surrec:0603
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  1. Fershtman, Chaim & Gneezy, Uri, 2001. "Strategic Delegation: An Experiment," RAND Journal of Economics, The RAND Corporation, vol. 32(2), pages 352-68, Summer.
  2. Chaim Fershtman & Kenneth L. Judd & Ehud Kalai, 1990. "Observable Contracts: Strategic Delegation and Cooperation," Discussion Papers 879, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. David M. Newbery, 2002. "Privatization, Restructuring, and Regulation of Network Utilities," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262640481, June.
  4. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, June.
  5. Urbiztondo, Santiago, 1994. "Investment without Regulatory Commitment: The Case of Elastic Demand," Journal of Regulatory Economics, Springer, vol. 6(1), pages 87-96, February.
  6. Lewis, Tracy R & Sappington, David E M, 1991. "Oversight of Long-Term Investment by Short-Lived Regulators," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(3), pages 579-600, August.
  7. Currie, David & Levine, Paul L & Rickman, Neil, 1999. "Delegation and the Ratchet Effect: Should Regulators Be Pro-Industry?," CEPR Discussion Papers 2274, C.E.P.R. Discussion Papers.
  8. Fershtman, C. & Kalai, E., 1993. "Unobserved Delegation," Papers 10-93, Tel Aviv - the Sackler Institute of Economic Studies.
    • Fershtman, Chaim & Kalai, Ehud, 1997. "Unobserved Delegation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 38(4), pages 763-74, November.
  9. Spulber, Daniel F & Besanko, David, 1992. "Delegation, Commitment, and the Regulatory Mandate," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(1), pages 126-54, March.
  10. Lyon, Thomas P, 1995. "Regulatory Hindsight Review and Innovation by Electric Utilities," Journal of Regulatory Economics, Springer, vol. 7(3), pages 233-54, May.
  11. Dalen, Dag Morten, 1995. "Efficiency-improving investment and the ratchet effect," European Economic Review, Elsevier, vol. 39(8), pages 1511-1522, October.
  12. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  13. Goodwin, Thomas H. & Patrick, Robert H., 1992. "Capital recovery for the regulated firm under certainty and regulatory uncertainty," Resources and Energy, Elsevier, vol. 14(4), pages 337-361, December.
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