Abstract
We model the regulation of irreversible capacity expansion by a firm with private information about capacity costs, where investments are financed from the firm’s cash flows and demand is stochastic. The optimal mechanism is implemented by a revenue tax that increases with the price cap. If the asymmetric information has large support, then the optimal mechanism consists of a laissez-faire regime for low-cost firms. That is, the firm’s price cap corresponds to that of an unregulated monopolist, and it is not taxed. This “maximal distortion at the top” is necessary to provide information rents, as direct subsidies are not feasible.
Keywords
regulation; real option value; asymmetric information; optimal contracts;
Reference
Bert Willems, and Gijsbert Zwart, “Optimal regulation of network expansion”, The RAND Journal of Economics, vol. 49, n. 1, Spring 2018, pp. 23–42.
See also
Published in
The RAND Journal of Economics, vol. 49, n. 1, Spring 2018, pp. 23–42