Optimal Investment in Network Infrastructures

We analyze the optimal investment in a common infrastructure in a market with network externalities. Taking a dynamic mechanism design perspective, we contrast the level of investment and the associated payments across firms that a budget-constrained welfare-maximizing principal would set to those emerging in an unregulated market. We consider two market scenarios: first, a nascent market in which only one firm operates and an entrant may arrive at a later stage; second, a more mature market in which two firms already operate. In these settings, the principal needs to set access fees so as to provide enough incentives to invest in the infrastructure, while also avoiding wasteful investment. At the same time, the principal needs to coordinate investment and usage of the shared network given the various externalities that each firm exerts. We highlight the relative importance of these two aspects and how regulation can be designed so as to improve social welfare. We also highlight how the optimal timing of investment depends crucially on the regulator’s coordination power.