A Modified Yardstick Competition Mechanism

Abstract

This paper analyzes a modified yardstick competition mechanism (MYC), where the yardstick employed consists of a tariff basket and total costs. This mechanism has a significant information advantage: the regulator "only" needs to observe total costs and output of all firms. The modified yardstick competition mechanism can ensure a socially optimal outcome when allowing for spatial and second degree price discrimination, without increasing the informational requirements. We also introduce regulatory lags in the model. A systematic comparison between the results of traditional yardstick regulation and modified yardstick regulation is carried out. Finally, we discuss the applicability of the mechanism.