Business Value and Risk in the Presence of Price Controls: An Option-Based Analysis of Margin Squeeze Rules in the Telecommunications Industry

Abstract

Pricing rules specific to the German telecommunications market limit the incumbents flexibility, providing a competitive advantage to all other market participants. More specifically, the incumbent is required not to offer products to its end customers at prices below a predetermined level in order to prevent margin squeezes. In contrast, competitors can freely choose their pricing strategy. In this paper, we propose the imposition of equivalent price barriers on all market participants in order to avoid price margin squeezes and reduce regulatory discrimination at the same time. We tailor a duopoly model to the German context, integrating the regulation of access pricing and price margin squeezes. Under standard parameter assumptions, we demonstrate that no economically significant effects on the value of market participants are observed for the case of market wide price regulation. We conclude that adjusting the current regulatory framework can enhance competition and increase welfare.

Keywords: telecommunications, real options, access pricing, margin squeezes, option games

JEL Classification: G13, G31, G38, K23, L11, L51, L96