Discussion paper

DP3200 Price Regulation, Investment and the Commitment Problem

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.


Levine, P and N Rickman (2002), ‘DP3200 Price Regulation, Investment and the Commitment Problem‘, CEPR Discussion Paper No. 3200. CEPR Press, Paris & London. https://cepr.org/publications/dp3200