Individual and Relative Regulation: An Investigation of Investment Incentives Under a Cost-plus Approach

Yassine Lefouili () and Nikos Ebel
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Yassine Lefouili: CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique
Nikos Ebel: IMW - Institute of Mathematical Economics - Universität Bielefeld = Bielefeld University

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Abstract: In this paper we analyze the effects of a modified Yardstick competition on firms' cost-reduction efforts. Departing from the existing literature, we use a relative cost-plus approach: firms are regulated on the basis of other firms' performances, but they are granted a mark-up instead of a lump-sum transfer in order to be compensated for their investments. We show that the cost-reduction effort of a regulated firm is decreasing in the mark-up under relative regulation while it is increasing in the mark-up under individual regulation. Hence, the trade-off between encouraging cost reduction and minimizing prices that the regulator faces under individual cost-plus regulation does not exist under relative cost-plus regulation. We extend our model by including technical spillovers and we investigate their effects on firms' cost reduction efforts and the efficiency of the whole industry. Finally, we allow for quality-enhancing investments and study the interplay between them and cost reduction investments.

Date: 2007-04
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Published in 3rd EBIM Workshop, Apr 2007, Bielefeld, Germany

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00318284

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