Calling the Cards: Fears, Threats and Delegation in Infrastructure Regulation Games

Infrastructure regulation under asymmetric information on cost and effort-averse agents is revisited in this paper from the perspective of pragmatic implementations of regulatory regimes by political princi- pals that have potentially non-aligned preferences. The political prin- cipal manipulates the independent regulator to leave rents to industry by two means; regulatory oversight by appeal courts and by imposing ex post participation constraints for yardstick regimes. First, along the lines of the law and regulation literature, we also assume that regulatory rulings can be appealed and repelled at high social costs if shown to be infeasible. By forcing the regulator to internalize these costs, the ex ante high-powered regimes are biased to provide higher information rents for a long period. Second, the yardstick regimes are powerful instruments to induce information revelation and productive efficiency under some conditions, one of them being a credible threat of bankruptcy. In our model, the weak political principal safeguards full participation from the full panel of firms by offering individual rationality constraints fulfilled ex post even under a yardstick regime, basically curtailing the regime to only offer upside gains. The frame- work presented in a stylized model shows that the fear for regulatory failure leads to welfare losses under all regimes, may distort choices of regulatory instruments and hampers information revelation. Some policy conclusions and analogies to the situation for the European economic regulation of electricity distribution system operators are given at the end of the paper