James J. Anton and Paul J. Gertler
Journal of Regulatory Economics 25 (2): 115-141, March 2004
Abstract: Many regulated industries involve imperfect competition or an oligopoly market structure. In this paper we examine optimal incentive regulation for a duopoly model of spatial competition when firms have private cost information. Market structure is endogenous in this setting as regulation determines market segments for firms and output distribution across consumers in each firm's market. By varying the assignment of consumers in the fringe area between market segments, the optimal policy provides incentives by rewarding a relatively more efficient firm with a larger market, thus reducing the need to rely on incentive provision via the familiar monopoly quantity distortion within a market segment. We derive the optimal policy and assess the impact of asymmetric information relative to full information. We also examine extensions to allow for several ex ante asymmetries in firm structure.