Common Agency with Horizontally Differentiated Principals : Regulating a Multinational Firm to extract Rent from Abroad

This paper analyses the mechanism design problem facing two countries (principals) who regulate the activity of a multinational firm (common agent) exporting in an international market. The multinational produces a differentiated product and has different costs in the two countries. This cost difference, or " country " preference, is private information of the firm. Each country offers a nonlinear tax schedule which depends on the level of domestic production. We show that the equilibrium regulatory mechanisms exhibit pooling of intermediate cost firms overproduce the same level of domestic production. Types of firms in this region produce the same level of output in both countries, pay a constant amount of aggregate taxes and makes zero rents. Outside of the pooling region production of each good decreases with marginal cost. In each country low cost firms underproduce and high cost firms overproduce relative to the full information levels. Furthermore, the tax schedule offered by a country is a nonmonotonic function of output produced in that country. For output levels greater (lower) than the one produced by types in the pooling interval each country’s taxes increase (decrease) with output. We compare the equilibrium contracts under noncooperative regulation with the ones that would prevail if countries coordinated their regulatory activities. We show that under coordinated regulation the output levels decrease faster with the firm’s cost, the tax schedules are steeper and the pooling region is larger. Finally, we show that while the producing countries gain from coordination of regulatory activities, the multinational firm always prefers a decentralized regulatory regime.