Commitment and Fairness in a Dynamic Regulatory Relationship

David P. Baron and David Besanko

The Review of Economic Studies, 1987, vol. 54, issue 3, 413-436

Abstract: This paper considers a multiperiod model of a regulated firm that has (stationary) private information which may be revealed through performance. If it cannot make commitments to future policies, the regulator has an incentive to exploit any information the firm reveals, and Laffont and Tirole show that there is no regulatory policy that is separating over any closed interval. A "fairness" arrangement is proposed in which the firm agrees not to quit if in future periods the regulator allows it to earn a nonnegative profit given the type it revealed in earlier periods. The properties of such arrangements are studied, and an example is presented in which both the firm and the regulator prefer a fairness arrangement to a policy feasible without commitment.

Date: 1987
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