REGULATION, COMPETITION, AND ASYMMETRIC INFORMATION

This article studies a model of regulation under asymmetric information when there exists a competitive fringe of unregulated alternative producers. The correlation between the unknown cost parameters of the fringe and of the regulated firm allows the regulator to use the threat of entry by the fringe to reduce the informational cost of regulation. The presence of the fringe is welfare enhancing. The allocative distortions can be larger or smaller than those in the no-fringe case, and the optimal contract sometimes allows inefficient entry. The optimal contract can exhibit non-standard bunching phenomena and discontinuities. © 1990.