THE DYNAMIC EFFICIENCY OF REGULATORY CONSTITUTIONS

In this article, we model regulation as a repeated game between a util ity facing a random sequence of demands and a regulator tempted to und erreward past investment. Rate-of-return regulation designed with a co nstitutional committment to an adequate rate of return on capital prud ently invested is able to support an efficient investment program as a subgame-perfect Nash equilibrium for a larger set of parameter values than rate-of-return regulation without such a commitment. Furthermore , rate-of-return regulation is superior to price regulation according to the same criterion, assuming that the regulator is unable to make s tate-contingent transfer payments.