Universal Service Obligations and Competition with Asymmetric Information

This paper takes into account adverse selection in the implementation of universal service obligations (USOs) for a network industry with no bypass. USOs are characterized by a coverage constraint imposed on the network’s owner. We develop fully the model for a welfare maximizing coverage constraint and explain how to adapt it for a full coverage (ubiquity) constraint. We use a market without USO as a benchmark case. We show that, because of information rents, a sufficiently high shadow cost of public funds can lead to a lower coverage with the USO than without it when firms turn out to be relatively inefficient. If the regulator is able to determine the industry structure by issuing licences to operate, the optimal number of firms reflects a trade-off between allocative efficiency and the industry capacity to finance internally the USO. The shadow cost of public funds then plays a dual role as it determines the terms of this efficiency funding trade-off in addition to the terms of the traditionnal efficiency rent trade-off.