Regulating a Manager-Controlled Monopoly with Unknown Costs

We study the regulation of a manager-controlled monopoly with unknown costs, borrowing from the earlier work of Baron and Myerson (BM)(1982), where the monopoly is controlled by the owner. Our regulatory environment involves the case where the regulator can tax the owner as well as the case where she cannot. We show that the optimal price schedule in our model generally lies below the one in the BM model. In addition, if the compensation parameter is sufficiently small, the optimal price can be as low as the marginal cost, provided that the regulator cannot tax the owner of the monopoly. We also examine how the size of the managerial compensation affects the welfare of the owner of the monopoly as well as the social welfare. Moreover, we show that in settings where the owner of a manager-controlled monopoly cannot be taxed, the owner prefers to separate management from ownership, provided that the marginal cost of production is sufficiently large. However, the owner always prefers to manage the monopoly herself when the marginal cost of production is sufficiently small.