Price regulation and quality

A growing concern on the part of regulators in the telecommunications and electric power industries is that the adoption of price-cap regulation may weaken incentives for investment in service quality. This analysis reveals that participation by the regulated firm in complementary, competitive markets may serve to temper this incentive. Paradoxically, commonly used revenue-share penalties can (actually) serve to reduce investment in quality. In contrast, profit-share penalties and increased information dissemination regarding the regulated firm's compliance with quality benchmarks provide unambiguous incentives for increased investment in quality, ceteris paribus.