The Effects of Uncertain Divestiture as Regulatory Threat

It has been argued that the threat of regulatory intervention affects firm behavior. We investigate the pricing decision of the dominant firm under regulatory threat, considering the probability of intervention as a function of the price. Our focus is on the case where the potential divestiture of the firm serves as a threat of regulatory intervention. Specifically, we compare regulatory threat, which can be regarded as uncertain intervention, with deterministic intervention. It is shown that under certain conditions associated with the marginal expected penalty, regulatory threat induces the firm to lower prices even more than deterministic intervention. Numerical examples illustrate that with relatively small-scale divestiture, the firm's price under regulatory threat may be lower than that under deterministic intervention within a relatively broad range of regulator's attitudes toward intervention