DP3200 Price Regulation, Investment and the Commitment Problem
Author(s): | Paul L Levine, Neil Rickman |
Publication Date: | February 2002 |
Keyword(s): | commitment, price regulation, under investment |
JEL(s): | L51 |
Programme Areas: | Public Economics, Industrial Organization |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=3200 |
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.