Franchise Bidding Without Holdups: Utility Regulation with Efficient Pricing and Choice of Provider

The idea of franchise bidding, as a governance structure for regulating natural monopoly, has remained dormant for the last twenty years, during which the technology and regulation of natural monopoly has changed considerably, both in theory and in practice. Meanwhile, auction theory has advanced significantly, independently of regulatory economics, which has moved in a different direction, namely price-cap regulation. We seek to combine the effects of the changes in the technology of network industries and the advances in bidding theory and in regulatory economics toward the development of a rigorous model of franchise bidding. The model presented in this paper, which develops conditions for efficient outcomes, provides a benchmark to begin a reconsideration of the potential of franchise bidding. In particular, for the first time, we complete Demsetz' (1968) proposal by specifying (second-price) rules for bidding and for transfer of assets when the incumbent loses the bid at re-auction. The scheme features one bid determining simultaneously output pricing and asset transfer pricing, to address concerns of hold-up and opportunistic behavior in the event of a change in franchisee.