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1999•RePEc: Research Papers in EconomicsOpen access

Collusion-Proof Yardstick Competition

Thomas P. Tangerås

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Abstract

This paper analyses the incentives for collusion when an industry is regulated by means of yardstick competition. The central assumption is that firms must write collusive side contracts before the revelation of private information and are unable to communicate later. It is shown that optimal collusion-proof regulation demands more high-powered (low-powered) incentives to high-productivity (low-productivity) firms than prescribed by the second-best contract. Collusion is costly to society also when correlation of private information is near perfect. This cintrasts with the result by Laffont and Martimort (1998b), that the cost of collusion vanishes in the limit.

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What this paper is about

This paper analyses the incentives for collusion when an industry is regulated by means of yardstick competition. The central assumption is that firms must write collusive side contracts before the revelation of private information and are unable to communicate later. It is shown that optimal collusion-proof regulation demands more high-powered (low-powered) incentives to high-productivity (low-productivity) firms than prescribed by the second-best contract. Collusion is costly to society also when correlation of private information is near perfect. This cintrasts with the result by Laffont and Martimort (1998b), that the cost of collusion vanishes in the limit.

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Available abstract

This paper analyses the incentives for collusion when an industry is regulated by means of yardstick competition. The central assumption is that firms must write collusive side contracts before the revelation of private information and are unable to communicate later. It is shown that optimal collusion-proof regulation demands more high-powered (low-powered) incentives to high-productivity (low-productivity) firms than prescribed by the second-best contract. Collusion is costly to society also when correlation of private information is near perfect. This cintrasts with the result by Laffont and Martimort (1998b), that the cost of collusion vanishes in the limit.

Key concepts: Yardstick, Collusion, Competition (biology), Incentive, Revelation, Private information retrieval, Industrial organization, Microeconomics

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