The Subsidiarity Bias in Regulation

We study the choice of the regulatory structure when a regulated firm engages in different activities for different countries. Under decentralization each activity is regulated independently and the contracts offered to the firm suffer from two opposite distortions with respect to centralization: the competition between regulatory authorities forces them to offer too high-powered incentive contracts; however, because the ownership structure of the firm is dispersed across the countries, each regulator does not fully internalize the effect of his regulation on the firm's rent and contracts tend to be too low-powered. When the activities of the firm are sufficiently substitutable we show that decentralization always leads to an inefficient drift of the regulatory contracts towards fixed-price contracts. Nonetheless, when regulators have private agendas and possess the discretion to distort their policy to gain the support of some interest groups, then decentralization of the regulatory powers may be preferred to centralization as competition between regulatory authorities eradicates their discretionary power