Contractual Design and Renegotiation: Impacts on Yardstick Competition Efficiency
Abstract: Yardstick competition models (YC) assume a perfect regulatory commitment that relies on complete and rigid yardstick contracts, which are never renegotiated. Therefore, YC makes it possible to provide strong incentives to firms, while decreasing the informational asymmetries. However, in reality, renegotiation may occur with YC, as noted by Hesseling and Sari [2006] for instance, in the case of the Dutch energy regulator. In this paper, I build a yardstick model that can explain the enforcement difficulties encountered in reality. I show that the introduction of a limited regulatory commitment leads to potential renegotiation of yardstick contracts and creates a trade-off in terms of contractual design. I show that a limited regulatory commitment doesn’t prevent from the implementation of YC, but requires an adaptation of the contractual design. The contractual design choice depends on the efficiency of renegotiation, the cost of public funds as well as the regulator's ability to manage endogenous and exogenous pressures (i.e. the probability that a rigid contract is renegotiated). These points (enforcement problems and choice of contractual design) are not taken into account in the literature on YC. However, as regards concrete implementation made by regulators, it seems that they are key variables in understanding the reality of this regulatory scheme.
