Advances in New Institutional Analysis series
Edited by Claude Ménard and Michel Ghertman
Chapter 12: Information Asymmetries and Regulatory Rate-Making: Case Study Evidence from Commonwealth Edison and Duke Energy Rate Reviews
Adam Fremeth and Guy L. F. Holburn INTRODUCTION Since Baron and Myerson (1982) a large theoretical literature has explored the impact of asymmetric information on the design of optimal regulatory policies for natural monopolies (Armstrong and Sappington, 2007; Laffont and Tirole, 1993). A central insight from this research is that regulators who are uninformed about firm costs or market demand conditions can maximize social welfare by offering pricing structures that effectively pay informational rents to the firm. These induce the firm to truthfully reveal true costs or market demand. Subsequent models have built on Baron and Myerson by adopting alternative assumptions on dimensions such as the firm’s technology, regulatory policy instruments and commitment abilities. Despite these theoretical extensions, there has been little empirical assessment of the relationship between asymmetric information and regulated rates. In this chapter we conduct a qualitative investigation of the relationship between regulators’ knowledge of regulated firms and their policy decisions. While directly observing the extent of regulatory knowledge presents a measurement challenge for researchers, we instead identify mechanisms through which information about regulated entities is revealed to external parties, including regulators. We focus our attention on three types of mechanism: the first considers the development of tacit knowledge through a regulator’s prior experience in office in the task of administering regulatory policies; the second is the publication of codified knowledge about a firm in the form of other agency, or judicial, rules or orders. Greater first-hand regulatory experience and greater amounts of 268 Information asymmetries and...
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