Bianchi, Milo and Yamashita, Takuro (2024) Optimal Investment in Network Infrastructures. TSE Working Paper, n. 1560, Toulouse

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Abstract

We analyze the optimal investment in a common infrastructure in a
market with network externalities. Taking a dynamic mechanism design
perspective, we contrast the level of investment and the associated payments
across firms that a budget-constrained welfare-maximizing principal would
set to those emerging in an unregulated market. We consider two market
scenarios: first, a nascent market in which only one firm operates and an
entrant may arrive at a later stage; second, a more mature market in which
two firms already operate. In these settings, the principal needs to set access
fees so as to provide enough incentives to invest in the infrastructure, while
also avoiding wasteful investment. At the same time, the principal needs
to coordinate investment and usage of the shared network given the various
externalities that each firm exerts. We highlight the relative importance of
these two aspects and how regulation can be designed so as to improve social
welfare. We also highlight how the optimal timing of investment depends
crucially on the regulator’s coordination power.