Strategic Choice of Financing Systems in Regulated and Interconnected Industries

The growing importance of inter-network exchanges in infrastructure-based utilities influencesregulatory choices and access pricing for downstream services using the networks. Weanalyze this problem in a setting where the infrastructure managers of two bordering countriesare in charge of pricing the access to their networks for downstream transport firms thatprovide international services. Network costs can be financed either through public fundsand user charges. Access prices are affected by the incomplete internalization of consumers’surplus and infrastructure costs; we analyze how this distortion at the access pricing levelgenerates a distortion in the levels of public funds dedicated to infrastructure financing.Because of these distortions, it turns out that in a non-cooperative setting the secondbestoutcome might consist in the simultaneous adoption of the no-subsidy system. However,multiple equilibria typically exist and the second-best outcome is never a stable equilibrium.Other properties of the different possible equilibria are studied, as well as the impact ofsupra-national policies aimed at encouraging the development of international services.The coordination problems deriving from the existence of multiple equilibria can, sometimes,be solved by separating the choice of a regulatory mode from the access pricing stage,thereby allowing the infrastructure managers to commit to use a specific financing systembefore setting the access price. However, our analysis unveils that, since the choice a regulatorymode in a country strategically affects the pricing of access in the other country,non-cooperative infrastructure managers might have free-riding incentives when decidingthe financing system for their own network.