Regulatory Holidays and Optimal Network Expansion

Bert Willems, Gijsbert Zwart

Research output: Working paperDiscussion paperOther research output

Abstract

We model the optimal regulation of continuous, irreversible, capacity expansion, in a model in which the regulated network firm has private information about its capacity costs, investments need to be financed out of the firm’s cash flows from selling network access and demand is stochastic. If asymmetric information is large, the optimal mechanism consists of a regulatory holiday for low-cost firms, and a mark-up regime for higher-cost rms. With the regulatory holiday, a firm receives the full revenue of capacity sales, and expands capacity as if it were an unregulated monopolist. Under the mark-up regime, a firm receives only a fraction of the capacity revenues, and is obliged to expand capacity whenever the price for capacity reaches a threshold. The regulatory holiday is necessary to fund information rents to the most efficient firms, which invest relatively early, as direct investment subsidies are not feasible.
LanguageEnglish
Place of PublicationTilburg
PublisherCentER, Center for Economic Research
Number of pages19
Volume2016-015
Publication statusPublished - 18 Apr 2016

Publication series

NameCentER Discussion Paper
Volume2016-015

Fingerprint

Holidays
Costs
Revenue
Markup
Asymmetric information
Direct investment
Capacity expansion
Information rent
Cash flow
Private information
Optimal regulation
Investment subsidies
Network access
Monopolist

Keywords

  • regulatory holiday
  • real option value
  • asymmetric information
  • optimal contracts

Cite this

Willems, B., & Zwart, G. (2016). Regulatory Holidays and Optimal Network Expansion. (CentER Discussion Paper; Vol. 2016-015). Tilburg: CentER, Center for Economic Research.
Willems, Bert ; Zwart, Gijsbert. / Regulatory Holidays and Optimal Network Expansion. Tilburg : CentER, Center for Economic Research, 2016. (CentER Discussion Paper).
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Willems, B & Zwart, G 2016 'Regulatory Holidays and Optimal Network Expansion' CentER Discussion Paper, vol. 2016-015, CentER, Center for Economic Research, Tilburg.

Regulatory Holidays and Optimal Network Expansion. / Willems, Bert; Zwart, Gijsbert.

Tilburg : CentER, Center for Economic Research, 2016. (CentER Discussion Paper; Vol. 2016-015).

Research output: Working paperDiscussion paperOther research output

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N2 - We model the optimal regulation of continuous, irreversible, capacity expansion, in a model in which the regulated network firm has private information about its capacity costs, investments need to be financed out of the firm’s cash flows from selling network access and demand is stochastic. If asymmetric information is large, the optimal mechanism consists of a regulatory holiday for low-cost firms, and a mark-up regime for higher-cost rms. With the regulatory holiday, a firm receives the full revenue of capacity sales, and expands capacity as if it were an unregulated monopolist. Under the mark-up regime, a firm receives only a fraction of the capacity revenues, and is obliged to expand capacity whenever the price for capacity reaches a threshold. The regulatory holiday is necessary to fund information rents to the most efficient firms, which invest relatively early, as direct investment subsidies are not feasible.

AB - We model the optimal regulation of continuous, irreversible, capacity expansion, in a model in which the regulated network firm has private information about its capacity costs, investments need to be financed out of the firm’s cash flows from selling network access and demand is stochastic. If asymmetric information is large, the optimal mechanism consists of a regulatory holiday for low-cost firms, and a mark-up regime for higher-cost rms. With the regulatory holiday, a firm receives the full revenue of capacity sales, and expands capacity as if it were an unregulated monopolist. Under the mark-up regime, a firm receives only a fraction of the capacity revenues, and is obliged to expand capacity whenever the price for capacity reaches a threshold. The regulatory holiday is necessary to fund information rents to the most efficient firms, which invest relatively early, as direct investment subsidies are not feasible.

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Willems B, Zwart G. Regulatory Holidays and Optimal Network Expansion. Tilburg: CentER, Center for Economic Research. 2016 Apr 18. (CentER Discussion Paper).