Munich Personal RePEc Archive

Rule Versus Discretion: Regulatory Uncertainty, Firm Investment, and the Ally Principle

Montagnes, B, Pablo and Wolton, Stephane (2015): Rule Versus Discretion: Regulatory Uncertainty, Firm Investment, and the Ally Principle.

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Abstract

Previous studies of the bureaucracy have focused on the internal relationship between politicians (principals) and bureaucrats (agents). External regulated actors, such as firms, have generally been ignored. But firms strategically respond to their regulatory environment and regulatory uncertainty can deter investment. We examine how concerns about firms' strategic behavior affect the optimal internal organization of the bureaucracy. When regulatory uncertainty is about how much firms will be regulated, the ally principle applies: the principal delegates to an agent with similar preferences as hers. When regulatory uncertainty is about whether firms will be regulated, the ally principle fails to hold: the principal prefers an inefficient rule-based regulatory framework or, if possible, to delegate to an agent with preferences distinct from hers to encourage firm investment. We uncover novel endogenous limits to delegation since the principal faces a commitment problem not to replace a biased agent after the firm investment.

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