Regulatory Holidays and Optimal Network Expansion

Bert Willems, Gijsbert Zwart

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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 firms. 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.
Original languageEnglish
Place of PublicationTilburg
PublisherTILEC
Number of pages17
Publication statusPublished - 18 Apr 2016

Publication series

NameTILEC Discussion Paper
Volume2016-008

Keywords

  • egulatory holiday
  • real option value
  • asymmetric information
  • optimal contract

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  • Cite this

    Willems, B., & Zwart, G. (2016). Regulatory Holidays and Optimal Network Expansion. (TILEC Discussion Paper; Vol. 2016-008). TILEC.