The Role of Informational Rents: Network Utilities and Vertical Structure

Abstract

This paper presents a theoretical assessment of the efficiency implications of alternative vertical structures in an industry characterized by a natural monopoly, vertically related to potentially competitive markets (network utilities). Based on the incomplete contracts and asymmetric information paradigm, I show that the monopoly’s informational rents vary according to the vertical structure of the industry. This, in turn changes the relative advantages of these alternative structures in terms of their allocative and productive inefficiencies. The main policy conclusion of this paper is that the existence of conglomerates in network industries matters. This paper’s contribution is that its exploration of the issue does not assume that monopolies behave in an uncompetitive fashion toward their rivals, as is common in the literature on this subject. This paper, therefore, offers an economic rationale for vertical separation.