Optimal regulation of network expansion

Willems, Bert;Zwart, Gijsbert
(2018) The Rand Journal of Economics — Vol. 49, n° 1, p. 23-42 (2018)

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We model the regulation of irreversible capacity expansion by a firm with private information about capacity costs, where investments are financed from the firm's cash flows and demand is stochastic. The optimal mechanism is implemented by a revenue tax that increases with the price cap. If the asymmetric information has large support, then the optimal mechanism consists of a laissez-faire regime for low-cost firms. That is, the firm's price cap corresponds to that of an unregulated monopolist, and it is not taxed. This “maximal distortion at the top” is necessary to provide information rents, as direct subsidies are not feasible.
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Willems, B., & Zwart, G. (2018). Optimal regulation of network expansion. The Rand Journal of Economics, 49(1), 23-42. https://doi.org/10.1111/1756-2171.12217 (Original work published 2018)