Abstract
In an incomplete regulation framework, the regulator cannot replicate all the possible outcomes by himself since he has no influence over some firms in the market. Due to asymmetric information, it may be better for the regulator to allow the unregulated firms to extract a truthful report from the regulated firm through side-payments under collusion, and therefore the “collusion-proofness principle” may not hold. In fact, by introducing an exogenous number of unregulated firms, social welfare differences seem to favour a collusion-allowing equilibrium. However, such result will depend on the relative importance given by the regulator to the consumer surplus in the social welfare function.
Highlights
This paper aims to evaluate the optimal incomplete regulation contract when it is possible to form a coalition between unregulated firms and the regulated firm, and the marginal costs of the regulated firm are private information, not available to the regulator and neither to the other competitors
We will evaluate how such results may be influenced by the relative importance given by the regulator to the consumer surplus in the social welfare function
We assume that db − da = θ1b − θ = θnb −θ, which means that the difference between the marginal costs of the most efficient unregulated firm (F1b) and the efficient type of FA is equal to the difference between the cost of the most inefficient firm in market B (Fnb) and the inefficient type of the regulated firm, and they are both equal to the difference between the size of the two markets. (We will see later on that the conclusions remain the same if we disregard such assumption.)
Summary
This paper aims to evaluate the optimal incomplete regulation contract when it is possible to form a coalition between unregulated firms and the regulated firm, and the marginal costs of the regulated firm are private information, not available to the regulator and neither to the other competitors. Biglaiser and Ma [12] focus on optimal incomplete regulation when only the dominant firm has private information regarding the demand function and the unregulated competitor has some market power, acting as a Stackelberg follower. They proved that depending on the weight given by the regulator to consumer surplus on social welfare, the equilibrium outcome could be both separating and pooling or just separating. We discuss the importance of the social welfare function to the robustness of such findings, by comparing the consumer surplus values in collusion-proofness and collusion-allowing equilibriums
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