Regulated Competition under Increasing Returns to Scale

This paper proposes a mechanism for the regulation of firms in the context of asymmetric information with the aim to induce firms to report its private information truthfully and to save information rents. Baron and Myerson (1982) have considered this problem and derived an optimal policy for regulating a monopolist with unknown costs. They show that it was possible to create a regulatory mechanism that induced the firm to report its private information truthfully. To secure this, a part of the mechanism is to pay the firm a subsidy. This article presents a regulatory mechanism which explores competition in the context of an industry characterized by increasing returns to scale. In contrast to the model in this article, the Baron and Myerson model doesn’t consider increasing returns to scale. In equilibrium each firm chooses to report truthfully without receiving any subsidy. However, the use of competition gives rise to an efficiency lost.