Abstract
Consider a vertically integrated electricity company that provides regulated local network services while being active in a deregulated but imperfectly competitive retail market for electricity. Its total costs are known, both to the regulator and its competitor, while the distribution between the two costs is private knowledge of the incumbent. The firm has a natural incentive to overstate its costs for the network services to receive a higher regulated price. However, since total costs of both operations are known, a claim of high network costs signals low retail costs. When firms compete in prices, which are strategic complements, the integrated firm would like its competitor to belief that retail costs are high as well. The regulator, through a combination of price incentives and monitoring, can utilize this trade-off and induce an information-revealing separating equilibrium in which the incumbent claims its true type. The optimal combination of price incentives and monitoring and the conditions under which such a separating equilibrium is preferred to a pooling equilibrium are derived.