DP9928 Consumer Standards as a Strategic Device to Mitigate Ratchet Effects in Dynamic Regulation

Author(s): Raffaele Fiocco, Roland Strausz
Publication Date: April 2014
Keyword(s): consumer standard, Dynamic regulation, limited commitment, ratchet effects, strategic delegation
JEL(s): D82, L51
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9928

Strategic delegation to an independent regulator with a pure consumer standard improves dynamic regulation by mitigating ratchet effects associated with short term contracting. A pure consumer standard alleviates the regulator's myopic temptation to raise output after learning the firm is inefficient. Anticipating this tougher regulatory behavior, efficient firms find it less attractive to exaggerate costs. This reduces the need for long term rents and mitigates ratchet effects. A welfare standard biased towards consumers entails, however, allocative costs arising from partial separation of the firms' cost types. A trade-off results which favors strategic delegation when efficient firms are relatively likely.