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Regulation with a Risk-Averse Principal

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  • Christophe Gence-Creux

    (University de Toulouse 1)

Abstract

We construct the optimal regulation contract between a risk-averse principal, such as a small municipality, and a risk-neutral private ''public service'' operator, such as a large multinational firm. With adverse selection, moral hazard and socially costly transfers, we show that the more risk-averse the principal, the more result oriented the contract. We also show that, for a given degree of the regulator's risk aversion, the larger the number of operators supervised by one regulator, the more high powered the incentive scheme. In a two period dynamic setting, we focus on the commitment issue. We define a measure of the social value of a regulator's ability to sign binding long term contracts, and we obtain that this increases with the degree of the principal's risk aversion. We discuss some political implications of these results in terms of regulatory institutions' design. Such issues like the efficiency of the contract, credibility or independence of the regulator are tackled with this concept of regulator's risk aversion.

Suggested Citation

  • Christophe Gence-Creux, 2000. "Regulation with a Risk-Averse Principal," Econometric Society World Congress 2000 Contributed Papers 0588, Econometric Society.
    • Handle: RePEc:ecm:wc2000:0588
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    References listed on IDEAS

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    2. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, April.
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    5. Tirole, Jean, 1986. "Procurement and Renegotiation," Journal of Political Economy, University of Chicago Press, vol. 94(2), pages 235-259, April.
    6. Laffont, Jean-Jacques & Rochet, Jean-Charles, 1998. "Regulation of a Risk Averse Firm," Games and Economic Behavior, Elsevier, vol. 25(2), pages 149-173, November.
    7. Caillaud, B. & Jullien, B. & Picard, P., 1996. "Hierarchical organization and incentives," European Economic Review, Elsevier, vol. 40(3-5), pages 687-695, April.
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    Cited by:

    1. Xavier d'Haultfoeuille & Philippe Février, 2007. "Identification and Estimation of Incentive Problems : Adverse Selection," Working Papers 2007-21, Center for Research in Economics and Statistics.
    2. Basov Suren & Yin Xiangkang, 2010. "Optimal Screening by Risk-Averse Principals," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 10(1), pages 1-25, March.

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