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Title: Price Regulation, Investment and the Commitment Problem

Author(s): Paul L Levine and Neil Rickman

Publication Date: February 2002

Keyword(s): commitment, price regulation and under investment

Programme Area(s): Industrial Organization and Public Economics

Abstract: 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 characterize the Perfect Bayesian equilibria and show that, with incentive contracts but without delegation, under- and over-investment can occur. 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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Bibliographic Reference

Levine, P and Rickman, N. 2002. 'Price Regulation, Investment and the Commitment Problem'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3200