Regulatory risk, vertical integration, and upstream investment

Raffaele Fiocco and Dongyu Guo

European Economic Review, 2020, vol. 128, issue C

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 noncontractible investment. 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 high upstream investment at a lower social cost. This occurs for moderate costs of high investment and firms’ 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
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:128:y:2020:i:c:s0014292120301458

DOI: 10.1016/j.euroecorev.2020.103514

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