Unbundling and Incumbent Investment in Quality Upgrades and Cost Reduction

We study the investment of a telecommunications incumbent in quality and in cost reduction when an entrant can use its network through unbundling of the local loop. We fi?nd that unbundling may lower incentives for quality improvements, but raises incentives for cost reduction. Therefore, it is not true that all types of investment are crowded out with unbundling. If the regulator can commit to a socially optimal unbundling price before investment, the incumbent makes both types of investment. In the absence of commitment, the incumbent will not invest, so that unbundling regulation may lower welfare as compared to no regulation.