Ex Post Regulation Facilitates Collusion

Deregulation and privatization of public utilities in grid-based industries raises the question on how to provide an efficient access to the network infrastructure to entering service providers. Often the incumbent firm which controls the grid is also active on the service market which requires access to the network and where it is competing with entering firms. Balancing the efficiency of service provision and the incentive to invest in the network infrastructure suffers a lack of information and creates a range of discretion to the regulator. Typically, the regulator has to mediate the conflict between the incumbent, which demands a high access fee, and the service entering providers, which complain about excessive access fees. The present analysis indicates for markets in which quality competition is essential that a vertically integrated incumbent benefits from a high access fee. Both the revenue from the access fees and preventing tough price competition are beneficial effects to the incumbent. Entrants will recognize that the access fee is above marginal cost and this gives rise to complaints and requests for reviews of the access rate by the regulatory body. However, if there is a single entrant which is protected from further entry the two active firms may agree upon an access fee that is higher than the marginal cost, which would be the efficient level. The reason is that the higher access fee serves as a commitment device to not engage in tough price competition. Therefore, the incumbent is also willing to raise its price, which results in higher revenue. In this situation a regulator does not face conflicting arguments by the incumbent and the entrant and, under ex post regulation, may not be alerted to review the level of the access fee.

Beschorner, Patrick (2008), Ex Post Regulation Facilitates Collusion, ZEW Discussion Paper No. 08-099, Mannheim.