How to Auction an Essential Facility When Underhand Integration is Possible

Eduardo Engel, Ronald Fischer and Alexander Galetovic

No 8146, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: There are many industries in which potentially competitive segments require services provided by natural monopoly bottlenecks (essential facilities). Since it is difficult to regulate these facilities, developing countries are using Demsetz auctions, where the facility is awarded to the firm that bids the lowest user fee. In this paper we show that when underhand agreements between the monopoly bottleneck and downstream firms are possible, Demsetz auctions need floors on bids, since otherwise welfare can be lower than with an unregulated monopoly. We model an underhand agreement using a standard hidden information model. The essential facility is an uninformed principal randomly matched to a downstream company, which observes its costs after closing the underhand agreement. When the essential facility prefers the option of vertical separation, there is downstream competition, which implies that only low cost firms survive. We find that a sufficiently high floor on bids promotes vertical separation, yielding higher welfare than either an unregulated or a vertically integrated monopoly. Moreover, prohibiting open vertical integration means this floor can be lower, thus enhancing welfare. The incentive compatibility constraints required by underhand agreements imply rent sharing and production distortions that make vertical integration less attractive.

JEL-codes: D44 L12 (search for similar items in EconPapers)
Date: 2001-03
Note: IO
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Published as Engel, Eduardo M. R. A., Ronald A. Fischer and Alexander Galetovic. "How To Auction A Bottleneck Monopoly When Underhand Vertical Agreements Are Possible," Journal of Industrial Economics, 2004, v52(3,Sep), 427-455.

Downloads: (external link)
http://www.nber.org/papers/w8146.pdf (application/pdf)

Related works:
Working Paper: How to Auction an Essential Facility When Underhand Integration Is Possible (2002)
Working Paper: How to Auction an Essential Facility When Underhand Integration is Possible (2002)
Working Paper: How to Auction an Essential Facility when Underhand Integration is Possible (2000)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:8146

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w8146

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().