Mechanisms for Incentive Regulation: Theory and Experiment

This article develops the theoretical properties of a new incentive mechanism for regulating a monopoly seller and reports the results of laboratory experimental tests of its behavioral properties. The design of the new mechanism draws upon the results of our earlier experimental research on the behavioral properties of two other mechanisms, one by Loeb and Magat (1979) and a second by Finsinger and Vogelsang (1981). As with Finsinger and Vogelsang, the new mechanism weakens Loeb and Magat's requirement that regulators have complete knowledge of market demand. The new mechanism, however, is not subject to the destabilizing, profit-destroying cycles of nonoptimal behavior observed with Finsinger and Vogelsang's.