Delegation and the Under-Investment Problem

Regulation Initiative Working Paper No. 32

Posted: 23 Sep 2002

See all articles by Paul Levine

Paul Levine

School of Economics, University of Surrey

Date Written: August 1999

Abstract

This paper addresses a long-standing problem in regulation: underinvestment arising from the regulator's incentive to exploit the sunk cost nature of the regulated firm's captial investment. A number of ways of alleviating the problem are suggested in the literature including the establishment of a commitment mechanism in the form of a legal or constitutional guarantee of a 'fair' rate of return (Greenwald, 1984) a trigger-strategy equilibrium appropriate when the firm and regulator meet repeatedly over a long period (Salant & Woroch 1992) and regulatory capture under asymmetric information (Laffont and Tirole 1993 chapter 11 and a review exercise). In this paper a new solution to this problem is provided in the simplest possible context.

Suggested Citation

Levine, Paul L., Delegation and the Under-Investment Problem (August 1999). Regulation Initiative Working Paper No. 32. Available at SSRN: https://ssrn.com/abstract=319889

Paul L. Levine (Contact Author)

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

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