Pricing by the Firm Under Regulatory Threat

Abstract

The theories of a profit-maximizing monopolist and of a regulated firm are well developed. Little attention, however, has been paid to the behavior of firms threatened with regulation. Regulation does not always appear as an unexpected event, and threatened firms may alter their behavior to reduce the probability of regulation. For example, Olmstead and Rhode [1985] tell the fascinating story of California oil companies in the 1920s. Standard Oil of California, the dominant firm and price-setter, refused to raise gasoline prices even though the real price of light crude had doubled. Similarly, during the 1979 gasoline crisis large oil companies such as Exxon and Mobil posted lower prices for gasoline and heating oil than did small companies [Erfle, Pound, and Kalt, 1981; Erfle and McMillan, 1990]. In a similar vein, Block and Feinstein [1986] find that highway construction costs are reduced after antitrust enforcement in neighboring states. These authors argue that fear of governmental regulation explains such behavior. This paper examines the politics of imposing regulation and its effect on the price chosen by a monopolist threatened with regulation. We consider a firm that is not yet regulated but that faces the risk of regulation. The probability of regulation is greater the higher the price the firm charges, and the more attentive are politicians to this issue. Once regulated, the firm remains regulated forever and earns constant profits in each subsequent period.' The firm chooses the product price to maximize the present value of its expected profits.Our emphasis differs from the literature on stochastic regulation (see Klevorick [1973] and Bawa and Sibley [1980]) which assumes that a firm already subject to regulation must charge a set price, but can decide how much capital and labor to use in production. Nor, despite its great interest, do we examine the policy that maximizes the welfare of consumers (this problem is treated by Baron and Myerson [1982]). The pricing decision we analyze *We are grateful for the comments of two anonymous referees of this Journal. 1. Recent experience in the airline, trucking, and telephone industries suggests that deregulation is a real possibility. However, the recent deregulatory movement occurred only after decades of regulation. The inertia of regulation is strong, and the agency responsible for regulation can have strong interests in continuing to regulate. It is not unreasonable, therefore, to simplify the problem by assuming that a firm once regulated continues to be so for the foreseeable future.

Strategic restraint in contests

“…See also Ursprung (1990) and Sun and Ng (1999). Finally, our result is also related to the studies of Cairns and Long (1991) and Glazer and McMillan (1992) on voluntary price regulation. Using different settings inspired by Becker's (1983) pressure model, these authors show that, within a monopoly context, the threat of price regulation due to an effective political opposition by consumers may induce the monopolist to price below the unregulated price.…”

“…4 For related results in the special context of monopoly regulation, see Cairns and Long (1991) and Glazer and McMillan (1992). Using the different setting of Becker's (1983) pressure model, these authors show that the monopolist is induced to price below the unregulated profit-maximizing price.…”

“…If, however, the one stage-game is conceived as a reduced form of a more complex two-stage game that allows for influence activities, as in Becker (1983), then (17) may hold with equalities or inequalities. Adding more costs (for example, costs due to increased political uncertainty, as in Glazer and McMillan (1992)), can only moderate the optimal policy proposals of the interest groups. Since adding influence costs can never increase the optimal policy proposals beyond the ones obtained under certainty conditions, the sign of the derivatives in (17) cannot be reversed.…”

Sales Force and Competition in Financial Product Markets: The Case of Mexico's Social Security Privatization

“…They may have feared the threat of regulation. This regulatory threat may have affected their fee strategy (e.g., Glazer and McMillan (1992), Stango (2003)). They may also have been uncertain of the longevity of the system and thus favored flow fees because they yield revenues immediately, rather than high balance fees that could pay off more in future years.…”

Pharmaceutical Prices and Political Activity

“…Figure 4 plots the weighted-average ratio of R&D to sales for the 15 companies in our sample for which we could get both R&D and sales data for the entire eleven-year period from 1986-1996 Glazer and McMillan (1992) (2) and allowing for a random error, we get: ln(P., / P,u-^^) = «^*. + P^,n +^^; v +^,, (3) To estimate equation (3) control for such possibilities, we estimated versions of equation (3) and report the results in A13.…”