Price cap regulation and information acquisition

In this paper we endogenize the information structure under price cap regulation. We show that, in order to induce the firm to acquire valuable but costly information, price cap mechanisms need to ensure high profits to the firm. Further, we compare incentives for information acquisition under price cap regulation and under the optimal mechanism designed to deal with the standard case where asymmetric information is assumed. We show that the latter provides higher incentives for information acquisition and that the welfare loss associated with price cap regulation - with respect to the optimal regulatory mechanism - increases when the issue of information acquisition is considered. (C) 2002 Elsevier Science B.V. All rights reserved.