Research
Published papers
Distortions in investment timing and quantity in real options with asymmetric information (De Economist, 2023)
with Maarten van Oosterhout
We analyze real options investment under asymmetric information on investment costs, where decisions not only involve investment timing, but also investment quantity. A principal, the regulator, offers a menu of contracts to the agent (the regulated firm). The regulated firm has better information on costs than the regulator, and the optimal regulation trades off distortions in investment decisions and informational rents left to the firm. In a non-dynamic situation, it is well known that optimal contracts involve downward distortions on investment quantity. In the dynamic, real options situation, distortions also occur in investment timing: a high-cost firm’s investment will be delayed beyond the optimal time, until revenues reach a higher investment threshold. We explore the effect on investment quantity in this real option regulation under various assumptions on the stochastic process for revenues. On the one hand, the higher investment threshold tends to increase investment quantities, whereas screening of high-cost firms would favour reducing their investment quantity. We find a simple sufficient condition for the latter, quantity-reducing, effect to dominate, and show that it is satisfied for a wide range of commonly used stochastic processes.
Optimal procurement and investment in new technologies under uncertainty (Journal of Economic Dynamics and Control, 147, 2023)
with Malin Arve
We study a buyer's optimal investment strategy for new technologies when costs evolve stochastically and are private information to the suppliers. In a real option setting, we show how the asymmetric information on the stochastic variables optimally distorts technology choice and investment timing. We find that with multiple technologies, asymmetric information may delay or speed up investment, compared to the first-best real option benchmark. We also suggest a payment structure that implements the buyer's optimal investment timing as a Vickrey-type auction.
Optimal regulation of energy network expansion when costs are stochastic (Journal of Economic Dynamics and Control, 126, 2021, Special Issue on Investment, Energy and Green Economy), (youtube lecture in the Economic Modeling Seminar Series of FEEM/University of Brescia)
We analyze optimal regulation of the gradual investments in energy networks necessary to accommodate the energy transition. We focus on a real option problem where costs of new network technology are stochastic and not observable to the regulator. We solve for the regulatory scheme that optimally balances timely investments with rent extraction in this dynamic agency context. We then apply this methodology to a situation in which investment can be either in traditional network technology, with observable costs, or using an innovative network technology for which there is asymmetric information on costs. The optimal choice trades off the potential benefits of cheaper expansion with the costs of overcoming information frictions.
Competition for traders and risk (RAND Journal of Economics, 49, Issue 4, 2018)
with Michiel Bijlsma and Jan Boone
Perverse incentives for banks' traders have played a role in the financial crisis. We study how labor market competition interacts with the structure of compensation to result in excessive risk taking. In a model with trader moral hazard and adverse selection on trader abilities, we demonstrate how banks optimally induce top traders to take more risk as competition on the labor market intensifies, even if banks internalize the costs of negative outcomes. Distorting risk‐taking incentives allows banks to reduce the surplus offered to low‐ability traders. We find that increasing bank capital requirements does not unambiguously reduce risk taking by top traders.
Optimal regulation of network expansion (RAND Journal of Economics, 49, Issue 1, 2018), (Top 20 downloaded paper at RAND, 2017-2018)
with Bert Willems
We model the regulation of irreversible capacity expansion by a firm with private information about capacity costs, where investments are financed from the firm's cash flows and demand is stochastic. The optimal mechanism is implemented by a revenue tax that increases with the price cap. If the asymmetric information has large support, then the optimal mechanism consists of a laissez‐faire regime for low‐cost firms. That is, the firm's price cap corresponds to that of an unregulated monopolist, and it is not taxed. This “maximal distortion at the top” is necessary to provide information rents, as direct subsidies are not feasible.
The complementarity between risk adjustment and community rating: Distorting market outcomes to facilitate redistribution (Journal of Public Economics, 155, 2017) (prepublication version)
with Michiel Bijlsma and Jan Boone
We analyze optimal risk adjustment in competitive health-insurance markets when insurers have better information on their customers' risk profiles than the sponsor of health insurance. In the optimal scheme, the sponsor uses reinsurance to screen insurers with bad and good risks, in order to lower premiums for enrollees with high expected healthcare costs. We then explore the effects of adding a community-rating requirement to complement this risk-adjustment scheme. With community rating, insurers have incentives to distort contract generosities to cherry-pick low-cost consumers. However, the reduced generosity for low-cost types makes screening through reinsurance easier, allowing the sponsor to redistribute more. When costs for reinsurance are low, or the sponsor's bias towards high-cost consumers is high, community rating dominates risk rating.
Targeted advertising, platform competition, and privacy (Journal of Economics and Management Strategy, 26, Issue 3, 2017), (featured article at JEMS)
with Henk Kox and Bas Straathof
Targeted advertising can benefit consumers through lower prices for access to web sites. Yet, if consumers dislike that web sites collect their personal information, their welfare may go down. We study competition for consumers between web sites that can show targeted advertisements. We find that more targeting increases competition and reduces the web sites' profits, but yet in equilibrium web sites choose maximum targeting as they cannot credibly commit to low targeting. A privacy protection policy can be beneficial for both consumers and web sites. If consumers are heterogeneous in their concerns for privacy, a policy that allows choice between two levels of privacy will be better. Optimal privacy protection takes into account that the more intense competition on the high‐targeting market segment also benefits consumers on the less competitive segment. Consumer surplus is maximized by allowing them a choice between a high‐targeting regime and a low‐targeting regime which affords more privacy.
Competition Leverage: How the Demand Side Affects Optimal Risk Adjustment (RAND Journal of Economics 45 Issue 4, 2014)
with Michiel Bijlsma and Jan Boone
We study optimal risk adjustment in imperfectly competitive health insurance markets when high‐risk consumers are less likely to switch insurer than low‐risk consumers. Insurers then have an incentive to select even if risk adjustment perfectly corrects for cost differences. To achieve first best, risk adjustment should overcompensate insurers for serving high‐risk agents. Second, we identify a trade‐off between efficiency and consumer welfare. Reducing the difference in risk adjustment subsidies increases consumer welfare by leveraging competition from the elastic low‐risk market to the less elastic high‐risk market. Third, mandatory pooling can increase consumer surplus further, at the cost of efficiency.
Trade quotas and buyer power, with an application to the EU natural gas market (Journal of the European Economic Association, Volume 12, Issue 1, 2014)
with Svetlana Ikonnikova
We consider a market in which domestic buyers negotiate contracts with foreign sellers, and explore how trade quotas can help to increase the buyers' countervailing power. We use the Shapley value to describe bargaining power and the distribution of the trade surplus in such a bilateral oligopoly. By exploiting strategic externalities among the buyers, bilateral trade quotas can improve the buyers' bargaining positions. In contrast, aggregate trade restrictions on all buyers' trade never improve buyer surplus. Minimum quotas on imports from fringe suppliers can benefit nonaffected buyers, as these enjoy positive externalities. We apply these insights to the E.U. market for natural gas and show that the effects of trade quotas on E.U. gas importers' power can be significant.
Optimal regulation of lumpy investments (Journal of Regulatory Economics, Volume 44, Issue 2, 2013)
with Peter Broer
We study optimal timing of regulated investment in a real options setting, in which the regulated monopolist has private information on investment costs. In solving the ensuing agency problem, the regulator trades off investment timing inefficiency against the dead-weight loss arising from high price caps. We show that optimal regulation is implemented by a price cap that decreases as a function of the monopolist’s chosen investment time.
European natural gas markets: resource constraints and market power (The Energy Journal, Volume 30, Special Issue, 2009)
The liberalized Dutch green electricity market: lessons from a policy experiment (De Economist, 151, 2004)
with Eric van Damme
Working papers
Moral hazard and risk adjustment (version August 2023)
We analyze a model of optimal risk adjustment in competitive health-insurance markets which suffer from both ex-ante adverse selection and ex-post moral hazard. We find, firstly, that, unlike in an adverse-selection-only market, in an environment where also moral hazard is important, removing insurers' selection incentives requires risk-adjustment payments that do not fully equalize costs among consumer types. Current practice of attempting to correct for all predictable cost differences among consumers is then misguided. Secondly, if the sponsor of the risk-adjustment system is not only concerned with eliminating selection distortions, but also wants to redistribute towards high-risk consumers, the required higher risk-adjustment payments will introduce selection distortions in high-risk consumers' contracts. This leads to excessive equilibrium provision of care for those suffering severe health shocks. Finally, insurer market power creates countervailing incentives, helping the risk adjuster to combat selection distortions but working against a risk-adjustment regulation that also cares about redistribution.
Choosing your battles: endogenous multihoming and platform competition (version April 2021)
with Marco Haan and Nannette Stoffers
We study how digital platforms can choose competitive strategies to influence the number of multihoming consumers. Platforms compete for consumers and advertisers. A platform earns a premium from advertising to singlehomers, as it is a gatekeeper to these consumers. Competitive strategies leading to intense competition on the consumer side reduce profits on that side, but also increase consumer singlehoming and hence market power over advertisers. The size of the singlehoming premium determines where this competitive strategy ‘seesaw’ will end up. We apply this insight to four strategic choices that may increase singlehoming: reducing product differentiation, portfolio diversification through conglomerate mergers, the choice of compatibility and tying.
Funding innovation under adverse selection and moral hazard (version August 2019)
We analyze optimal financing of an entrepreneur’s real option to invest in innovation when investors do not observe the stochastic quality process driving the investment’s value. Optimal contracts encourage entrepreneurs to postpone investment by paying them for waiting. When there is adverse selection on initial quality, high quality entrepreneurs invest inefficiently early to signal their type. In the presence of moral hazard, paying before investment reduces entrepreneur incentives to work, and in response, also in this case the optimal contract induces early investment.