Dynamic Natural Monopoly Regulation:Time Inconsistency, Asymmetric Information,and Political Environments
Claire S.H. Lim
Cornell University
Ali Yurukoglu
Stanford University
July 20, 2014
Abstract
This paper quantitatively assesses time inconsistency, asymmetric information, and political ideology in monopoly regulation of electricity distribution companies. Empirically, we estimate that (1) there is under-investment in electricity distribution capital to reduce power outages, (2) more conservative political environments have higher regulated returns, and (3) more conservative political environments have more electricity lost in distribution. We explain these empirical results with an estimated dynamic game model of utility regulation featuring investment and asymmetric information. We quantify the value of regulatory commitment in inducing more investment. Conservative regulators improve welfare losses due to time inconsistency,but worsen losses from asymmetric information.
Keywords: Regulation, Natural Monopoly, Electricity, Political Environment, Dynamic Game Estimation
JEL Classification: D72, D78, L43, L94
