REGULATION AS A BARGAINING PROCESS - NEGOTIATION OVER PRICE AND COST-REDUCING INVESTMENTS

This paper develops the idea that industry regulation can be treated a s a bargaining between a firm and the public authority, and illustrate s some consequences of this formulation. We investigate a typical regu latory problem, where a firm chooses a cost-reducing investment before price is subject to regulation. In a standard scheme, investment will be lower than required by efficiency. If the possibility of negotiati on is taken into account, we then show that this undercapitalisation r esult can be reversed. Indeed, with sunk costs we can observe excessiv e capitalisation.