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Competition, Regulation and Managerial Incentives

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  • Gianni De Fraja
  • Elisabetta Iossa

Abstract

This paper examines the effects of a competitive fringe on a regulated firm. Using Hart's (1983) model, we show that competition weakens the managerial incentives for cost reduction: when there is correlation between the cost levels of the firms in the industry, costs are higher in the regulated firm than when costs are independent. We also show that incentives are further weakened by an increase in the number of firms. Moreover, under analogous circumstances the regulated firm shows higher costs than private managerial firms. We end our paper by drawing a potentially important conclusion on the design of regulatory mechanisms: we show that there might be considerable gains (in terms of both lower prices and managerial incentives for cost reduction) if the regulatory target is set in terms of output, rather than price. In this case the presence of competition determines a reduction in slack.
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Suggested Citation

  • Gianni De Fraja & Elisabetta Iossa, "undated". "Competition, Regulation and Managerial Incentives," Discussion Papers 94/30, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:94/30
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    JEL classification:

    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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