This chapter reviews recent theoretical work on the design of regulatory policy, focusing on the complications that arise when regulated suppliers have better information about the regulated industry than do regulators. The discussion begins by characterizing the optimal regulation of a monopoly supplier that is better informed than the regulator about its production cost and/or consumer demand for its product. Both adverse selection (“hidden information”) and moral hazard (“hidden action”) complications are considered, as are the additional concerns that arise when the regulator's intertemporal commitment powers are limited. The chapter then analyzes the design of practical policies, such as price cap regulation, that are often observed in practice. The design of regulatory policy in the presence of limited competitive forces also is reviewed. Yardstick regulation, procedures for awarding monopoly franchises, and optimal industry structuring are analyzed. The chapter also analyzes the optimal pricing of access to bottleneck production facilities in vertically-related industries, stressing the complications that arise when the owner of the bottleneck facility also operates as a retail producer.

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Recent developments in the theory of regulation

The Theory of Peak-Load Pricing: A Survey.

The new economics of regulation is an application of the principal-agent methodology to the contractual relationship between regulators and regulated firms. After a critique of the traditional paradigms of regulation from the point of view of information economics a canonical model of regulation under asymmetric information is developed. A survey of the main results obtained in the new economics of regulation is then provided, in particular concerning the implementation of optimal contracts by a menu of linear contracts, the dichotomy between pricing and cost reimbursement rules, the auctioning of incentive contracts, the dynamics of contracting under limited commitment, and the hierarchical problems in regulation. Empirical implications are then discussed and avenues of further research are described in the conclusion.

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The new economics of regulation ten years after

The last thirty years have witnessed a fundamental change in the regulation of infrastructure industries Whereas firms were subject to rate of return regulation and protected from entry in the past, now they face various forms of incentive regulation, competition is actively promoted by many regulators, and both regulators and the firms they regulate must often confront rapid technological progress This paper surveys the literature on the investment implications of different regulatory schemes, highlighting the relevance of modern investment theory, which puts risk and intertemporal issues, such as the irreversibility of much infrastructure investment, center stage It discusses the impact on regulated monopolists' investment behavior of key regulatory characteristics, namely the price flexibility allowed by the regulator, the length of the regulatory cycle, and the costs the regulator will allow the firm to recover at future regulatory hearings It also considers the impact of competition, especially the situation where a vertically integrated firm has its operation of a bottleneck asset regulated, on investment by regulated firms and their competitors

/pdf/regulating-infrastructure-the-impact-on-risk-and-investment-2w7skms5xs.pdf

Regulating Infrastructure: The Impact on Risk and Investment

Design of regulatory mechanisms and institutions

This paper describes an incentive mechanism that is shown to enforce the use of Ramsey prices by multiproduct monopolies. The constraint given is simple. It limits information requirements on the regulatory agency to bookkeeping data of the firm. Its implementation could be easily controlled by outside courts or auditors. The process, therefore, makes use of invisible hand properties shifting the workload of welfare optimization from the regulatory agency to the regulated firm.

/pdf/a-regulatory-adjustment-process-for-optimal-pricing-by-4ad0vxfomo.pdf

Jörg Finsinger

Papers

A regulatory adjustment process for optimal pricing by multiproduct monopoly firms

Strategic Management Behavior Under Reward Structures in a Planned Economy

Markup Pricing and Firm Decisions

Non-competitive and protectionist government purchasing behavior

Peak load pricing and rationing policies