We present a model featuring irreversible investment, economies of scale, uncertain future demand and capital prices, and a regulator who sets the firm’s output price according to the cost structure of a hypothetical replacement firm. We show that a replacement firm has a fundamental cost...

Incentive regulation allows decentralised decision-making under regulatory parameters set on the basis of industry characteristics. When there is uncertainty, sunk costs, and flexibility in the timing of investment a monopoly will invest later than is socially desirable because it garners only a...