How to Get Firms to Invest: A Simple Solution to the Hold-Up Problem in Regulation

15 Pages Posted: 5 Nov 1999

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: September 1999

Abstract

Many governmental programs are effective only if firms make costly investments. The inability of authorities to precommit to a regulatory scheme creates incentives for firms not to invest and to hold up the regulator. This paper describes a simple subsidy/tax scheme embedded in a four-stage mechanism that solves the hold-up problem. We design a self-financing subsidy/tax scheme which benefits a complying firm at the expense of a non-complying firm. In order to be credible, the subsidy and tax rates must maximize social welfare for any combination of investment decisions. We show that there exists a unique subgame perfect equilibrium in which all firms invest and no actual implementation with subsidies and taxes is required. We discuss in which cases the mechanism can work under incomplete information.

JEL Classification: L23, L51

Suggested Citation

Gersbach, Hans, How to Get Firms to Invest: A Simple Solution to the Hold-Up Problem in Regulation (September 1999). Available at SSRN: https://ssrn.com/abstract=180808 or http://dx.doi.org/10.2139/ssrn.180808

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Research ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Centre for Economic Policy Research (CEPR)

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