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Investment Incentives under Price-Cap Regulation

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DOI: 10.4236/tel.2012.25105    6,097 Downloads   7,820 Views   Citations
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ABSTRACT

In the literature on price regulation, the price-cap mechanism is seen as a very powerful incentive mechanism towards efficiency improvements. What about quality investments? The empirical literature is not univocal: Some studies suggest a deterioration of quality, while others do not find any statistically significant impact. We analyze the incentive provided by price-cap regulation in a setting in which the investment decisions of the regulated firm suffer from hold-up, and contacts are incomplete. We show that the incentives to invest in cost-saving innovations can be fostered by a price-cap contract with a “sufficient” regulatory lag, while for other types of investments, such as quality enhancement, the same contract does not help. Furthermore, we show that if the firm faces a binding resource constraint the price-cap contract generates a crowding-out effect between the two types of investment. This might explain the non univocal empirical evidence.


Conflicts of Interest

The authors declare no conflicts of interest.

Cite this paper

D. Bartolini, "Investment Incentives under Price-Cap Regulation," Theoretical Economics Letters, Vol. 2 No. 5, 2012, pp. 570-575. doi: 10.4236/tel.2012.25105.

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