THE REGULATION OF MULTIPRODUCT FIRMS .1. THEORY

This paper develops a normative model of the regulation of a multiproduct firm with private information about its technology and cost-reducing activity. It first characterizes the optimal regulatory scheme and illustrates it through examples. It then derives necessary and sufficient conditions for the 'pricing-incentive dichotomy' to hold, i.e. conditions under which the cost reimbursement rule, but not pricing, is used to provide incentives. Last, the paper studies the regulation of the multiproduct firm in a general equilibrium framework both to assess the validity of the partial equilibrium approach and to formalize the notion of 'taxation by regulation'. © 1990.