Lobbies, delegation and the under-investment problem in regulation

A time-inconsistency problem in regulation often results in under-investment especially where there are high sunk costs in network industries such as electricity, gas, telecommunications and water. This paper provides a new perspective on this 'hold-up' problem facing the price regulation of a firm with market power where full commitment to a price regime is not possible. We compare a political equilibrium based on a voting model with lobbying with a delegation equilibrium, where a government can delegate to a particular 'type' of pro- or anti-industry regulator. Our analysis suggests two possible ways in which we may observe price regulation that encourages socially optimal investment in the absence of externally imposed regulatory commitment: first, there is less than total transparency in which voters receive an optimal amount of information and second, the decisions on price are delegated to a sufficiently, but not excessively, pro-industry regulator. (C) 2006 Elsevier B.V. All rights reserved.