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Opting-out in profit-sharing regulation

  • Michele Moretto

    (University of Brescia)

  • Paola Valbonesi

    (University of Padova)

To avoid the extremely high profit levels found in recent experiences with price cap regulation, some regulators have proposed a profit-sharing mechanism that revises prices to the benefit of consumers. This paper investigates the conditions under which a regulator can implement such a profit-sharing scheme, having the option to revoke the contract if the firm's profits are excessive. When this option is included in the regulator's objective function and the cost of exercising it is not too high, a long-term equilibrium arises with a state-contingent sharing rule that guarantees and appropriate level of profits. The model determines both the level of profits that triggers the profit- sharing mechanism and the consequent price adjustment endogenously. There is an endogenous regulatory lag initially characterized by a price cap regulation, followed by a period of profit-sharing regime where the firm is motivated to cut prices to avoid revocation.

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File URL: http://econwpa.repec.org/eps/io/papers/0403/0403001.pdf
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Paper provided by EconWPA in its series Industrial Organization with number 0403001.

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Length: 40 pages
Date of creation: 02 Mar 2004
Date of revision:
Handle: RePEc:wpa:wuwpio:0403001
Note: Type of Document - pdf; pages: 40
Contact details of provider: Web page: http://econwpa.repec.org

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