Regulating a risk-averse firm under incomplete information

We examine the optimal regulatory policy for a risk-averse firm when the firm is imperfectly informed about its efficiency parameter for a project at the time of contracting. The firm’s risk aversion shifts the optimal regulatory policy from a fixed-price contract to a cost-plus contract. The optimal regulatory policy entails undereffort by an inefficient firm as in Laffont and Tirole (J Polit Econ 94(3):614–641, 1986) and the effort distortion increases as the firm becomes more risk-averse. Further, the regulator benefits from sequential contracting with the firm where the firm chooses contract terms gradually as it acquires information, albeit the benefit diminishes as the firm becomes more risk-averse.      

Environmental enforcement when ‘inspectability’ is endogenous: A model with overshooting properties

If a firm can influence its monitorability vis-à-vis an environmental regulator, it is shown that increasing the thoroughness of inspections induces the firm to substitute towards more transparent technologies, whilst increasing their frequency may cause substitution the other way. Perversely, when the effect of such substitution is taken into account, an increase in the frequency of inspections (or, equally, the stringency of penalties) may worsen the firm's environmental performance. The agency should favour more thorough inspections than existing theory suggests, particularly in sectors where the scope for such substitution is great. Moreover, when monitorability adjusts only sluggishly to policy shocks (because it is an embodied characteristic of capital, for example) the environmental impacts of increased frequency and increased thoroughness well over- and under-shoot their respective long-run impacts. In assessing regulatory reform, therefore, it is important to leave sufficient time for the class of adjustments identified to occur. The possibility of overshooting can be used as an alternative to existing regulatory capture theories to explain why the efficacy of some classes of regulatory reform may fade through time.     

The Need for Regulating a Bayesian Regulator

This paper analyzes the Baron and Myersons (B–M) (Econometrica 50: 911–930 [1982]) scheme of monopoly regulation, a standard representative of Bayesian mechanisms. As is well known, the hboxB–M mechanism (and other related mechanisms) have as an explicit starting point the assumption that the regulator has an unchallenged prior belief about the cost function of the regulated monopolist.We analyze here the consequences resulting from the possibility that this prior belief may be subject to influence or manipulable. As we show in detail, under the B–M scheme, consumers and the regulated monopoly are highly sensitive to the regulators prior belief about the (private) cost information of the monopolist. Therefore, if a regulators beliefs are unaccountable to and unverifiable by a higher ity, the regulator has both the incentive and the possibility to change and/or misrepresent his prior belief when facing pressure or payoffs from interest groups representing consumers or the regulated firm. The results here show that the outcomes under a B–M mechanism favoring one or another interest group can vary over a wide spectrum. The results are consistent with capture theory and rent-seeking explanations of monopoly regulation and suggest the need to exercise care in using the insights and results of Bayesian regulatory theory to inform practice.     

Investment Incentives of a Regulated Dominant Firm

We study the investment incentives of a regulated, incumbent firm in a deregulation process. The regulator cannot commit to a long-term regulatory policy, and investment decisions are taken before optimal regulatory policies are imposed. We characterize the regulated incumbent's incentive to invest when a deregulation process is initiated and an unregulated firm enters the market as a result. The change in the marginal return to investment depends on how the investment changes the firm's virtual cost—the sum of its physical production and information costs. When the marginal return to investment increases due to deregulation, social welfare increases as a result of higher investment and more competition. Otherwise, the change in social welfare depends on the total of the effects in the fall of investment and increased competition. We also present conditions under which deregulation enhances welfare.     

Regulation and information in a continuing relationship

Regulation typically involves a continuing relationship between a regulator and a firm, and that relationship is often complicated by asymmetric information. A multiperiod model of this relationship is analyzed in which a regulated firm has private information about its costs which may changed over time in a manner observable only to the firm. The regulator is assumed to be able to commit to a policy for the entire regulatory horizon, and the optimal pricing policy is shown to depend on an informativeness measure that indicates how information by the firm in one period will be used in future periods.     

Behavioral economics: implications for regulatory behavior

Behavioral economics (BE) examines the implications for decision-making when actors suffer from biases documented in the psychological literature. This article considers how such biases affect regulatory decisions. The article posits a simple model of a regulator who serves as an agent to a political overseer. The regulator chooses a policy that accounts for the rewards she receives from the political overseer—whose optimal policy is assumed to maximize short-run outputs that garner political support, rather than long-term welfare outcomes—and the weight the regulator puts on the optimal long run policy. Flawed heuristics and myopia are likely to lead regulators to adopt policies closer to the preferences of political overseers than they would otherwise. The incentive structure for regulators is likely to reward those who adopt politically expedient policies, either intentionally (due to a desire to please the political overseer) or accidentally (due to bounded rationality). The article urges that careful thought be given to calls for greater state intervention, especially when those calls seek to correct firm biases. The article proposes measures that focus rewards to regulators on outcomes rather than outputs as a way to help ameliorate regulatory biases.     

我国地方殡葬业管制失灵与成因：基于管制俘获理论的解释

作为转轨经济体普遍存在的一种社会经济现象,管制俘获正受到越来越多的关注。而我国地方殡葬行业改革为研究利益集团俘获政府提供了一个理想的实验。论文将哈尔滨市殡葬行业作为馆所分离管制模式的代表进行分析,认为殡葬服务机构主要通过自身影响力干预政府管制,创造为特定部门产生高度垄断收益的政策和制度扭曲,使威胁到租金流抽取的改革遭到拒绝,并推断实行馆所分离的其他城市殡葬业也可能存在类似的管制俘获问题。     

A Theory of Soft Capture

In this paper, we propose an alternative model for capture that is based not on reciprocity but on congruence of interests between the firm and the regulator. A regulator is charged by a political principal to provide an imperfect signal for the type of a regulated firm. Only the firm can observe its type, and the production of a signal is costly. The firm can provide a costless alternative signal of lower accuracy to the regulator. In a self‐enforcing equilibrium, the regulator transmits the firm‐produced signal and saves information‐gathering costs, and the firm enjoys higher information rents.     

Product innovation,signaling, and endogenous regulatory delay

This paper examines the determinants of the timing of a monopolistic firm’s product innovation and regulatory approval, and proposes a signaling model with endogenous regulatory delay. Regulatory delay exerts a multiplier effect on total time to market, because when the firm expects the regulator to take longer to grant approval, the firm delays its product introduction. The firm can time its innovation to communicate its private information about the marginal cost of delay to the regulator. Successful signaling in the separating equilibrium leads the regulator to reduce regulatory delay. The implications of the model are consistent with data on innovation and regulatory delay in telecommunications markets in a few Midwest states in the US.      

Regulating a Monopolist with Unknown Demand: Costly Public Funds and the Value of Private Information

In this paper, we analyze the optimal regulation policy when the regulated firm has better information concerning the market demand than the regulator. We show that introducing a cost on public funds into the Planner's objective function does not lead to qualitative results similar to those obtained by introducing distributional considerations. In particular we show that under constant marginal cost the full information policy is not implementable and that the optimal regulatory policy results in informational rents. The social value of private information and the firm's informational rents are both increasing functions of the cost of the public funds.     

Pollution Accumulation and Firm Incentives to Accelerate Technological Change Under Uncertain Private Benefits

The paper explores the relationships between the design of public incentives and the policy-maker's desired timing of abandonment of a polluting technology, when this requires an irreversible private investment and the firm faces uncertain appropriable benefits from the technological change. Two regulatory approaches are examined. Firstly, we consider the quite common one of lowering the private investment cost, through a subsidy, in order to bridge the gap between the private and the policy-maker's desired timing of environmental innovation. Secondly, we consider a policy scenario where the regulator, instead of simply lowering the investment's rental price, also stimulates abandonment of the polluting technology by reducing – through appropriate announcements – the uncertainty surrounding the technological switch's private profitability. We then compare the two approaches and show the latter's benefits, in terms of the policy's effectiveness and/or budgetary savings.     

Environmental adders in the real world

This paper evaluates the use of environmental ‘adders’ as a regulatory instrument. It evaluates their likely performance in meeting the policy objective of social costing given the changes in the electric utility industry's structure and in environmental policy since the efforts to estimate these costs were initiated. The prognosis is largely negative — suggesting that environmental adders are inconsistent with the increased competition already underway in the utility industry, as well as with the trend toward greater use of true market-based approaches to environmental policy that are not subject to detailed economic regulation.     

On the design of regulatory price adjustment mechanisms

Price adjustment mechanisms are employed in the electric utility industry to pass changes in fuel costs on to consumers without formal rate review by a regulatory commission. The predictability of this pass-through and the regulator's limited ability to observe the actions of a firm can create potential incentive problems associated with the choices of technology and fuel supply. This paper is concerned with the regulatory design of pass-through formulas when a factor price is uncertain. The optimal design involves deviating from the full-information optimal price formulas in order to mitigate the incentive problems.     

Formal Rules versus Informal Relationships: Prudential Banking Supervision at the FSA Before the Crash

Prior to the 2007–9 banking crisis, the UK Financial Services Authority presented itself as a ‘proportionate’ and ‘risk-based’ regulator, preferring firms to adhere to the spirit of high-level principles rather than the letter of detailed rules. Simultaneously, it developed a supervisory regime that was unprecedentedly complex, producing a ‘Handbook’ of intricate secondary legislation that ran to some 8000 pages. Explaining these contradictory aspects of the pre-crisis regime demands a reappraisal of the dominant explanations of the supervisory failures that contributed to the banking crisis. In contrast to accounts that focus on officials' uncritical adherence to efficient market thinking (regulatory groupthink) or the political clout of the financial industry (regulatory capture), this article suggests that supervisory officials' actions can be understood only by reference to their institutional and structural contexts. Amid heightened public sensitivity to risk, officials developed an elaborate and transparent supervisory framework as a defence against potential political censure. At the same time, collegial firm–supervisor relationships were preserved as state-of-the-art risk-management ideas were recombined and repackaged in line with the institutional legacies of earlier ‘club-like’ modes of supervision. Together, these divergent tendencies contributed to overconfidence in the use of predictive risk assessment and neglect of banks' fundamental business risks.     

Universal service obligations in LDCs: The effect of uniform pricing on infrastructure access

This paper develops a model to analyze the impacts of asymmetric information on optimal universal service policy in the public utilities of developing countries. Optimal universal service policy is implemented using two regulatory instruments: pricing and network investment. Under discriminatory pricing asymmetric information leads to a higher price and smaller network in the rural area than under full information. Under uniform pricing the price is also lower but the network is even smaller. In addition, under both pricing regimes not only the firm but also taxpayers have incentives to collude with the regulator.     

Using Market Structure to Regulate a Vertically Integrated Monopolist

A natural monopolist whose cost is private information produces a good which is combined with another good that can be produced by the monopolist or by other firms. The agency that regulates the monopolist can impose any of several different market structures in the industry: integrated monopoly, vertical separation with free entry downstream, or liberalization downstream (both integrated and independent production). When several firms produce downstream, a Cournot quantity-setting game with free entry determines the market price. We derive the optimal contracts to offer the monopolist under all three market structures and examine the influence of downstream cost differences on access prices.We then study the optimal regulatory policy where the regulator can condition the downstream market structure on the monopolist's cost report to the regulator. The optimal regulatory policy awards a monopoly to a low-cost upstream firm, but requires free entry downstream if the monopolist reports high upstream costs. Thus, the choice of market structure is an additional tool to limit rent extraction by the monopolist. Simulation analysis reveals the possibility of significant welfare gains from this additional regulatory tool.     

Standards and the regulation of environmental risk

We study regulatory design for a pollution-generating firm who is better informed than the regulator regarding pollution mitigation possibilities, and who chooses an unobservable action when employing a particular mitigation plan. We distinguish among performance, process, and design standards, and study the relative merit of each type of regulatory instrument. Relative to previous work on standards design, we emphasize technology and process verification. An optimal performance standard is relatively strict when regulator and firm preferences are congruent, but the regulator may prefer no performance standard at all if verification costs are sufficiently high. A process standard unambiguously increases expected surplus (relative to no regulation) in some environments, and otherwise improves welfare only when it is unlikely to generate a “bad” technology choice by the firm. A design standard can improve welfare if the regulator is sufficiently well informed about the technological possibilities for pollution control, but only when the firm’s private benefits from technology choice are sufficiently small.     

Consumer confusion over the profusion of eco-labels: Lessons from a double differentiation model

How are eco-label strategies affected by consumer confusion arising from the profusion of eco-labels? This article provides a theoretical insight into this issue using a double differentiation framework. We assume that consumers perceive a label as a sign of quality compared to an unlabeled product, but that they cannot fully assess the environmental quality associated with each label and only see each label as a particular variety of a similar product. We analyze the pricing strategies of three firms, each one providing one product: a labeled product, with high or medium environmental quality, according to the eco-label, or an unlabeled product. We infer lessons for eco-labeling policies, according to the identity of the certifying organization: the regulator, an NGO or the firms. We show that the firm supplying the eco-labeled product with a high environmental quality is weakened by consumer confusion while the firm selling the unlabeled product suffers from strict labeling standards, to the benefit of the firm providing the labeled product with a lower environmental quality, which gains a competitive advantage. Most labeling policies consist of harmonizing labeling criteria, but only certification by a third party, the regulator or a NGO, guarantees the high environmental quality of labeled products, whereas certification by firms leads to a uniform undemanding standard. However, when both labels are provided by two different certifiers, including a firm, harmonization of environmental standards does not occur and the NGO's or regulator's eco-labeling standard will be much more stringent than the firm's one, preventing NGO's or public eco-labeling policy to significantly enhance quality of the environment and welfare.     

Carrot and yardstick regulation: Enhancing market performance with output prizes

The fundamental objective of most regulatory mechanisms is to expand output at a sufficiently low cost to consumers. Many useable mechanisms, such as Loeb and Magat's, require detailed demand information and substantial profit recapture by the regulator in order to achieve this objective. We present an apparently unexplored alternative approach-inducing competition among firms for shares of a monetary reward. Payments to a firm for output expansion thus depend on both its own behavior and the actions of other firms, which can even be firms in unrelated industries. We show that in a wide variety of circumstances, the resultant increase in consumer surplus exceeds the reward. Hence, even with no profit recapture, our approach can lead to Pareto improvements.     

Estimates for the optimal control policy in the presence of regulations and heavy tails

We consider a classical heavy tailed risk model, included in a regulation mechanism. The regulator exercises a minimal cash requirement level and penalties for violating it to regulate the insurance firm. The problem of the insurance firm is to establish an investment and risk exposure policy as well as a barrier dividend strategy, which is a function of the strategy used by the regulator. For regularly varying tailed claim size distributions, we find the asymptotics of the stationary distribution of the risk model and derive fundamental asymptotic results of the insurance firm's problem. In the special case of Pareto claim size distributions, the asymptotic optimal control policy is found in closed form, as well as numerical results.