Regulatory risk, vertical integration, and upstream investment

Raffaele Fiocco and Dongyu Guo

MPRA Paper from University Library of Munich, Germany

Abstract: We investigate the impact of regulatory risk on vertical integration and upstream investment by a regulated firm that provides an essential input to downstream competitors. Regulatory risk reflects uncertainty about the regulator's commitment to a regulatory policy that promotes the regulated firm's unobservable investment effort. We show that, when the regulator sets the regulatory policy after the vertical industry structure has been established, some degree of regulatory risk is ex ante socially beneficial. Regulatory risk makes vertical integration profitable and stimulates upstream investment at a lower social cost. This occurs for moderate costs of investment effort and firm small risk aversion. Our analysis sheds new light on some relevant empirical patterns in vertically related markets.

Keywords: commitment; moral hazard; regulatory risk; upstream investment; vertical integration; vertically related markets. (search for similar items in EconPapers)
JEL-codes: D82 L43 L51 (search for similar items in EconPapers)
Date: 2020-01
New Economics Papers: this item is included in nep-com, nep-mic and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Regulatory risk, vertical integration, and upstream investment (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:97960

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