Working Paper: CEPR ID: DP3200
Authors: Paul L. Levine; Neil Rickman
Abstract: 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.
Keywords: commitment; price regulation; under investment
JEL Codes: L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic delegation to a suitable regulator (G18) | improved investment incentives (G31) |
| strategic delegation to a suitable regulator (G18) | amelioration of the ratchet effect (O39) |
| regulatory preferences (L98) | investment levels (F21) |
| delegation to a pro-industry regulator (L51) | enhanced beliefs about retaining future profits (D25) |
| enhanced beliefs about retaining future profits (D25) | increased investment (E22) |