Natural monopoly regulation in the presence of cost misreporting

This paper explores the implications of asymmetric cost information within the context of a regulated natural monopoly. The paper provides a unifying framework for the analysis of cost padding and exaggeration, both of which are referred to simply as misreporting of costs. The paper studies the incentives embedded in the regulatory regime itself and shows how simple comparative statics may be useful in detecting falsification of the cost report which the regulated firm must submit to the regulator.