The dark side of price cap regulation: a laboratory experiment
TL;DR: In this article, the authors compare a baseline when regulators have the same information as firms about demand with treatments wherein they receive only a noisy signal and another when they know only the distribution from which demand realizations are taken.
Abstract: In a nutshell, price cap regulation is meant to establish a quid pro quo: regulators are obliged by law to intervene only at rare, previously defined points in time, and only by imposing an upper bound on prices; firms are meant to justify regulatory restraint by adopting socially beneficial innovations. In the policy debate, a potential downside of the arrangement has featured less prominently: the economic environment is unlikely to be stable while the cap is in place. If regulators take this into account, they have to decide under uncertainty and also anticipate how regulated firms will react. In a lab experiment, we manipulate the degree of regulatory uncertainty. We compare a baseline when regulators have the same information as firms about demand with treatments wherein they receive only a noisy signal and another when they know only the distribution from which demand realizations are taken. In the face of uncertainty, regulators impose overly generous price caps, which firms exploit. In the experiment, the social damage is severe, and does not disappear with experience.
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TL;DR: In this paper , the welfare effect of the temporary price cap implemented in 2017 on the Turkish electricity market was evaluated using matching and panel data methods, and it was shown that this decision was driven by noneconomic motives, and identified a number of fundamental problems in the Turkish market that limit the effective functioning of the market.
6 citations
TL;DR: In this paper, the authors investigated the impacts of price cap regulation on the internal actions of regulated water companies in England and Wales through an application of the theory of institutional isomorphism.
Abstract: This paper investigates the impacts of price cap regulation—weighted average cost of capital reductions determined by The Water Services Regulation Authority (Ofwat)—on the internal actions of regulated water companies in England and Wales through an application of the theory of institutional isomorphism. More specifically, the paper examines the potential impacts of the most recent 2014 PR14 reduction on (1) potential homogeneity of regulated firm behavior and (2) the likely impact on stakeholders, including shareholders, consumers, and employees of regulated water companies. We hypothesize that firms face isomorphic pressures in the wake of WAAC reductions that influence firm behavior regarding financing, investment decisions, profitability and returns to shareholders, service quality and consumer price, and impact on employees and employment levels. The methods utilized include a targeted analysis of available reported water industry annual reports and financial statements and semi-structured interviews with industry professionals. Interview results reveal that companies will utilize debt to fund investment in the future, with a smaller proportion of retained earnings, and that the PR14 reduction would result in downward pressure regarding water companies’ credit ratings. Interviewees stated that the WACC had minimal impact on investment decision-making, but may reduce profitability and returns to shareholders. Regarding service levels and quality, interviewees predict that service levels will remain the same, while consumer prices will decrease or remain the same. Trends towards potential employee reductions were evident through redundancies or the merging of departments.
4 citations
28 Feb 2019
TL;DR: The authors summarizes the major theoretical and empirical contributions to the literature on economic regulation, provides an overview of the various groups that can capture the regulatory process, and summarizes more recent contributions highlighting regulation's regressive effects and the "revolving door" between regulatory agencies and regulated firms.
Abstract: Economic orthodoxy before 1971 suggested that regulatory intervention could improve on market outcomes in cases of market power, negative spillover effects, or asymmetric information. That orthodoxy was overturned in 1971 with the publication of George Stigler’s “Theory of Economic Regulation,” which concludes that regulatory agencies are vulnerable to capture by special interest groups who shape regulatory outcomes in ways that benefit the regulated industry itself at consumers’ expense. Many empirical studies have since then confirmed Stigler’s theoretical insights. This chapter summarizes the major theoretical and empirical contributions to the literature on economic regulation, provides an overview of the various groups that can capture the regulatory process, and summarizes more recent contributions highlighting regulation’s regressive effects and the “revolving door” between regulatory agencies and regulated firms.
3 citations
TL;DR: This article conducted an experiment in which 107 law students who had completed their first year (including a course on Contracts) were asked to decide one of 6 contract law disputes, based on Australian appellate cases resulting in 2:1 majority decisions.
Abstract: This paper reports the results of an experiment in which 107 law students who had completed their first year (including a course on Contracts) were asked to decide one of 6 contract law disputes. The experiment was designed to replicate and extend earlier experiments. The disputes were based on Australian appellate cases resulting in 2:1 majority decisions. Three of them were classified as relatively ‘easier’ and 3 as relatively ‘harder’ to decide, based on the earlier experiments. The participants were instructed to make their decisions using a statement of relevant law drawn from either Australian case law or the draft Australian Contract Code published by the Victorian Law Reform Commission in 1992. We sought to contrast two plausible points on the spectrum of ‘detailed rules’ to ‘broad rules’ that were as far apart as possible. At 4 points in the decision process (after reading the facts, after reading the law, after formulating the arguments for each party and after their decision) the participants were asked to rate the importance of 15 facts drawn from the statement of facts. These facts had been classified by the researchers into 3 categories, based on their relative weight under both law models. In the extensive scholarly literature on ‘rule determinacy’ it is nearly universally assumed that detailed rules are more predictable than broad rules. It is also commonly asserted that a reason detailed rules are more certain is that they focus the necessary factual inquiry on a relatively small number of important facts, whereas broad rules lead decision makers to give greater importance to a relatively wider range of facts. Despite their importance, these assumptions have scarcely been tested empirically. This study contributes to that task. Our experimental results indicate that, contrary to conventional wisdom, broad rules are as predictable as detailed rules, and are more predictable in some cases. They confirm conventional wisdom on the focusing effect of detailed rules. But this effect was not associated with greater predictability. If anything, it seemed to make some cases needlessly unpredictable. This paper also reports our attempt to explore the assumed relationship between the scope of the factual inquiry and predictability of decisions, using a connectionist-network model to simulate the decision and fact importance rating results observed in each of the six cases used in our experiment. The model accounts for over 99% of the variance in our experimental data, using only 5 parameters for each case to account for the results of both law model groups (18 data points). Our results support the hypothesis that, again contrary to conventional wisdom, narrowing the factual inquiry reduced rather than increased predictability in all but one case. We explore the implications and limitations of our findings in the conclusion. Our interest in this topic arises from its relevance to the codification and international harmonization of contract law. Our results suggest that resistance to contract codes, in jurisdictions like Australia and the UK, based on their indeterminacy lacks an empirical foundation. They also suggest that a global contract code based on commonalities that can readily be discerned in existing contract codes, particularly at the level of broad rules, could be an effective instrument of contract regulation.
2 citations
Posted Content•
TL;DR: In this article, the authors proposed a multi-contract cost sharing (MCCS) mechanism for situations where the contractor knows more about the true costs of various projects than does the contracting agency (adverse selection), and unobservable effort on the part of the contractor may lead to cost reductions.
Abstract: In this paper we propose and test a contracting mechanism, Multi-Contract Cost Sharing (MCCS), for use in the management of a sequence of projects. The mechanism is intended for situations where (1) the contractor knows more about the true costs of various projects than does the contracting agency (adverse selection), and (2) unobservable effort on the part of the contractor may lead to cost reductions (moral hazard). The proposed process is evaluated in an experimental environment that includes the essential economic features of the NASA process for the acquisition of Space Science Strategy missions. The environment is complex and the optimal mechanism is unknown. The design of the MCCS mechanism is based on the optimal contract for a simpler related environment. We compare the performance of the proposed process to theoretical benchmarks and to an implementation of the current NASA ‘cost cap’ procurement process. The data indicate that the proposed MCCS process generates significantly higher value per dollar spent than using cost caps, because it allocates resources more efficiently among projects and provides greater incentives to engage in cost-reducing innovations.
2 citations
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TL;DR: In this article, the authors draw on recent progress in the theory of property rights, agency, and finance to develop a theory of ownership structure for the firm, which casts new light on and has implications for a variety of issues in the professional and popular literature.
49,666 citations
TL;DR: Z-Tree as mentioned in this paper is a toolbox for ready-made economic experiments, which allows programming almost any kind of experiments in a short time and is stable and easy to use.
Abstract: z-Tree (Zurich Toolbox for Ready-made Economic Experiments) is a software for developing and conducting economic experiments. The software is stable and allows programming almost any kind of experiments in a short time. In this article, I present the guiding principles behind the software design, its features, and its limitations.
9,760 citations
"The dark side of price cap regulati..." refers methods in this paper
...It was fully computerized, using the software zTree (Fischbacher 2007)....
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TL;DR: In this paper, it was pointed out that many of the current disputes with regard to both economic theory and economic policy have their common origin, it seems to me, in a misconception about the nature of the economic problem of society.
Abstract: Many of the current disputes with regard to both economic theory and economic policy have their common origin, it seems to me, in a misconception about the nature of the economic problem of society. This misconception in turn is due to an erroneous transfer to social phenomena of the habits of thought we have developed in dealing with the phenomena of nature.
8,226 citations
Book•
01 Jan 1971
TL;DR: In this article, the authors argue that regulation is acquired by the industry and is designed and operated primarily for its benefit, and that the state has one basic resource which in pure principle is not shared with even the mightiest of its citizens.
Abstract: The state—the machinery and power of the state—is a potential resource or threat to every industry in the society. With its power to prohibit or compel, to take or give money, the state can and does selectively help or hurt a vast number of industries. Regulation may be actively sought by an industry, or it may be thrust upon it. A central thesis of this paper is that, as a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit. The state has one basic resource which in pure principle is not shared with even the mightiest of its citizens: the power to coerce. The state can seize money by the only method which is permitted by the laws of a civilized society, by taxation. The state can ordain the physical movements of resources and the economic decisions of households and firms without their consent.
7,956 citations
TL;DR: In this article, the authors designed an experiment to study trust and reciprocity in an investment setting and found that observed decisions suggest that reciprocity exists as a basic element of human behavior and that this is accounted for in the trust extended to an anonymous counterpart.
5,033 citations
Additional excerpts
...The main experiment is followed by a standard trust game (Berg et al. 1995), with money sent by the trustor to the trustee tripled....
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