Essays on price regulation

The thesis consists of three chapters. In Chapter I (Price Caps with Capacity Precommitment), we study the effectiveness of price cap regulation in a monopolistic setting under demand uncertainty. In our model, a monopolist facing an uncertain demand. In the absence of capacity precommitment, price caps remain an effective regulatory instrument, just as they are when demand is deterministic. Price caps are also an effective instrument to regulate a monopoly that makes irreversible capacity investments ex-ante, and then chooses its output up to capacity upon observing the realization of demand. In this scenario, however, the optimal price cap must trade off the incentives for capacity investment and capacity withholding, is well above the unit cost of capacity and, when the unit cost of capacity is low, is below the price cap that maximizes capacity. Moreover, a price cap alone cannot eliminate inefficiencies. Under standard regularity assumptions on the demand distribution, the comparative static properties of price caps above the optimal price cap are analogous to those they have in the absence of capacity precommitment. The Chapter II and Chapter III are aimed at analyzing the competitive consequences of imposition of the Arm s Length Principle (ALP, henceforth) requirements for international transfer pricing. In order to discourage tax shifting activities by multinational fi rms, most countries follow taxation policies that are based on the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, which recommend that, for tax purposes, internal pricing policies be consistent with ALP (i.e., that transfer prices between companies of multinational enterprises for tax purposes be established on a market value basis, thus comparable to transactions between independent, unrelated, parties). Moreover, ALP puts associated and independent enterprises on a more equal footing for tax purposes, it avoids the creation of tax advantages that would otherwise distort the relative competitive positions of either type of entity. The failure to comply with the ALP may result in a penalty. The OECD s recommendation that transfer prices between parent firms and their subsidiaries be consistent with the ALP for tax purposes does not restrict internal pricing policies. In Chapter II ( Strategic Incentives for Keeping One Set of Books under the Arm s Length Principle ), we show that under imperfect competition parent rms accounting policies determine the properties of market outcomes: if parents keep one set of books (i.e., their internal transfer prices are consistent with the ALP), then competition in the external (home) market softens (intensi es) relative to an equilibrium where parent fi rms and subsidiaries are integrated. In contrast, if rms keep two sets of books (i.e., their internal transfer prices differ from those used for tax purposes) or maintain asymmetric accounting policies, then competition intensi es in both markets. Keeping one set of books turns out to be an equilibrium for most of the parameter space. In Chapter III ( The Non-Neutrality of the Arm s Length Principle with Imperfect Competition ), we show that under imperfect competition the Arm s Length Principle is non-neutral: a strict (lax) application of the ALP softens competition among subsidiaries (parents). Thus, under imperfect competition regulating transfer pricing optimally requires trading off its impact on market outcomes and tax revenue.