Self-Regulation Under Asymmetric Cost Information

In this paper, we study how a monopolistic firm with unknown costs may behave under the threat of regulation. To this aim, we integrate the self-regulation model of Glazer and McMillan (1992) with the optimal regulatory mechanism devised by Baron and Myerson (1982) for the case of asymmetric information. Simulating the equilibrium outcome of our integrated model for a wide range of parameter values, we show that the firm threatened with regulation always constrains its price; moreover, it does so more stringently if it is less efficient. If the marginal cost of the firm is sufficiently close to the highest possible value according to the beliefs of the legislators and the regulator, the price the firm charges under the threat of regulation can be even lower than the price it has to charge when it is regulated. Our simulations also reveal how the welfares of consumers and the threatened firm may be affected in the short-run and long-run by possible variations in several attributes of our model, involving the marginal cost of production, the number of legislators, each legislator's cost of proposing a regulatory bill, the size of the market, and the weight of the firm's welfare in the social welfare function