Regulation through a revenue contest

Abstract

This paper proposes a mechanism for the regulation of duopolies: a revenue contests among the firms. Under the mechanism, the firm with the lower revenue is to pay a penalty to the firm with the higher revenue proportional to the difference between their revenues. In a homogenous good Cournot duopoly with convex cost and demand functions, the mechanism implements the optimal outcome when the firms have symmetric costs. When one firm is more efficient, the mechanism leads to increased social surplus under a large set of parameters.

Pretend‐but‐perform regulation of a duopoly under three competition modes

“…Earler et al (2007), Roques and Savva (2009), Grimm and Zöttl (2010), Reynolds and Rietzke (2016), and Okumura (2017) consider the price-cap regulation that are frequently used in Cournot (and/or Stackelberg) oligopolies and show that a reduction of the price-cap level may decrease the social welfare under certain demand and/or cost conditions. Evrenk and Zenginobuz (2010), who study the problem of regulation in a non-linear Cournot duopoly, propose a regulatory mechanism in the form of a revenue contest where the firm with the lower revenue must pay a penalty fee (to the other firm) that is proportional to the difference between their revenues. They show that this mechanism implements the first-best social outcome if the firms are symmetric with respect to their costs, while it may lead to increased social surplus if the firms are asymmetric.…”

“…For instance, in Koray and Sertel (1989), the regulated duopoly is linear (and symmetric), and it is an open problem whether their results can be extended to non-linear duopolies as well. In Gradstein (1995) and Evrenk and Zenginobuz (2010), to check whether the mechanism is individually rational for the firms (i.e., their participation constraints are satisfied), the regulator would require complete information about the cost (and demand) structure. This informational assumption is also needed in Liao and Tauman (2004) so that the regulator can correctly calculate the social optimum that she is tasked to implement.…”

Regulated Competition under Increasing Returns to Scale

“…In Evrenk and Zenginobuz (2010), the duopolists are regulated through a revenue contest, whereby the firm with lower revenue must transfer some of its profits to the other firm. The work of Sengupta and Tauman (2011) deals with an oligopolistic market with increasing returns to scale technology, where the incentive mechanism is based on a bidding contest, the outcome of which is a contract with subsidies to only one firm, while the other firms exit the market.…”

“…Regulated oligopoly was treated by Wolinsky (1997) in the context of spacial competition, The idea of selecting from potential producers is exploited by Wang (2000) in a model of regulating an oligopoly with unknown cost, where only firms reporting low cost are allowed to stay in the market. In Evrenk and Zenginobuz (2010), the duopolists are regulated through a revenue contest, whereby the firm with lower revenue must transfer some of its profits to the other firm. The work of Sengupta and Tauman (2011) deals with an oligopolistic market with increasing returns to scale technology, where the incentive mechanism is based on a bidding contest, the outcome of which is a contract with subsidies to only one firm, while the other firms exit the market.…”