During the 1970s and 1980s we witnessed a renewed interest in the regulation of natural monopolies and oligopolies. In the policy arena discontent was expressed with the price, quality, and cost performance of regulated firms. The remedies sought in specific industries differed remarkably: More powerful incentive schemes were proposed and implemented, deregulation was encouraged to free up competition and entry, and in some countries changing in ownership (privatization) occurred. Meanwhile the academic debate attempted to shed light on some shortcomings of the generally accepted theory of regulation such as rate-of-regulation. Regulatory theory largely ignored incentive issues. The limited access to information of regulators was the source of inefficient regulatory outcomes. Furthermore, the considerable simplified formal models that assumed away imperfect information were less realistic in that they implied policy recommendation that require information not available to regulators in practice.
Many of the incentive schemes proposed recently have aimed to promote competition, to encourage economic efficiency and to streamline regulator's workloads under asymmetric information. Although significant results have been obtained in the way of designing and justifying alternative approaches, there still remains an important class of economic problems that are difficult to solve by those approaches and that arise frequently in several applications: regulation of interdependent economic agents in the context of asymmetric information.
The basic question is how to make an optimal incentive scheme which will induce firms to do what is best in the context of asymmetric regulatory information. How then can the regulator be sure that prices by the firms are maximizing the regulator's objective? For the case in which the regulator knows some economic information such as demand or total cost, some regulatory incentive schemes solve this problem through a generous subsidy. By subsidizing the firms for the losses they incur at marginal-cost prices, the firms can remain solvent and continue to produce at these prices indefinitely. The question then becomes: what regulatory mechanisms can the regulator use to attain the first-best outcome, given that it is able to subsidize the firms?
This thesis aims to develop a synthetic approach to the question of economic incentives in regulation. In the process, we devote to formalizing, giving an answer this question, and analyzing the answer. In the way of designing and analyzing the incentive schemes, we construct a generalized optimal subsidy scheme for regulating product-differentiated oligopoly market under asymmetric regulatory information where the regulator has no information about firms' cost structure. This is set up in such a way that equals its contribution to social surplus that is attributable to it: a synthetic approach to the theory of compensation for contribution. We also discuss further extensions of the theory in order to take real world situation into consideration and analyze several applications including environmental policy and R&D policy.
The main contributions of the thesis are that the economic implications of our analysis provide some insights into the process and purpose of the incentive regulation such that the way one thinks about economic incentives and the approach one takes in handling individual problems that arise in a regulatory setting of multiple agents in the context of asymmetric information.
