Regulating investments in vertically related industries

This paper studies how investment outcomes in a vertically related industry with a regulated monopolist and downstream competition are affected by diverse regulation imposed investment regimes and the nature of product market competition. We analyze the situation when the regulator determines which segment of the industry, the upstream monopolist or the downstream competitors, is in charge of the investment. With imperfect regulation of the industry, we show that investment outcomes vary substantially with the investment regime. The nature of competition (Cournot vs. Bertrand competition) has significant influence on the welfare maximizing investment regime. While under Cournot competition the downstream investment regime is always superior, under Bertrand competition the upstream investment regime provides relatively strong incentives to invest. Hence, a range of parameters exists where under different modes of competition different investment regimes are superior.