Dag Morten Dalen

Yardsticks on the road: Regulatory contracts and cost efficiency in the Norwegian bus industry

In this paper a cost frontier model is estimated for an eleven-year panel of Norwegian bus companies (1136 company-year observations) using the methodology proposed by Battese and Coelli (1995). The main objective of the paper is to investigate to what extent different type of regulatory contracts affect company performance. The panel model proposed by Battese and Coelli (1995) allow for year/company specific efficiency measures to be estimated. Thus, unobservable network or other time invariant characteristic of the operating environment can be controlled for by analyzing the dynamics of measured productivity across time for firms regulated under different types of contracts, rather than relying solely on variations across companies during one time period. Therefore, the paper offers methodological and data advantages over previous work on this subject. The main and robust result of the paper is that the adoption of a more high-powered scheme based on a yardstick type of regulation significantly reduces operating costs. The results contained in this paper thus confirms theoretical predictions regarding the incentive properties of high powered incentive schemes and in particular the dynamic benefits of yardstick competition.

Price regulation and generic competition in the pharmaceutical market

In March 2003 the Norwegian government implemented yardstick-based price regulation schemes on a selection of drugs subjected to generic competition. The retail price cap, termed the “index price,” on a drug (chemical substance) was set equal to the average of the three lowest producer prices on that drug, plus a fixed wholesale and retail margin. This is supposed to lower barriers of entry for generic drugs and to trigger price competition. Using monthly data over the period 1998–2004 for the six drugs (chemical entities) included in the index price system, we estimate a structural model enabling us to examine the impact of the reform on both demand and market power. Our results suggest that the index price helped to increase the market shares of generic drugs and succeeded in triggering price competition.

Diffusion of pharmaceuticals: cross-country evidence of anti-TNF drugs

This article studies the diffusion of biopharmaceuticals across European countries, focusing on anti-TNF drugs, which are used to treat autoimmune diseases (e.g., rheumatism, psoriasis). We use detailed sales information on the three brands Remicade, Enbrel and Humira for nine European countries covering the period from the first launch in 2000 until becoming blockbusters in 2009. Descriptive statistics reveal large variations across countries in per-capita consumption and price levels both overall and at the brand level. We explore potential sources for the cross-country consumption differences by estimating several multivariate regression models. Our results show that large parts of the cross-country variation are explained by time-invariant country-specific factors (e.g., disease prevalence, demographics, health care system). We also find that differences in income [gross domestic product (GDP) per capita] and health spending (share of GDP) explain the cross-country variation in consumption, while relative price differences seem to have limited impact.

Estimating cost functions in regulated industries characterized by asymmetric information

Abstract In this paper a structural model is developed to estimate a cost function that includes both an adverse selection and a moral hazard variable. It is shown how traditional cost function estimates may produced biased results if moral hazard is present. This gives an alternative reason to Feinstein and Wolak [The econometric implications of incentive compatible regulation, In: G.F. Rhodes, ed., Advances in econometrics, Vol. 9, 159–204 (JAI Press, Greenwich, CT, 1991)] of why scale economics may be overestimated in regulated industries. Parameter estimates from our model can be used to design an optimal contract or any other regulatory mechanism. We illustrate our approach using data from the Norwegian bus transport industry.

Efficiency-improving investment and the ratchet effect

Abstract In a long-term relationship between a regulator and a firm the production technology may change due to investment. This paper investigates how the introduction of such an investment possibility influences the dynamic regulation problem when long-term commitments are infeasible. Contractible investment is shown to reduce the ratchet effect by increasing separation in the first period. Due to the separation effect of investment, the first-period optimal scheme converges toward the optimal scheme with commitment as investment increases. Finally, assuming noncontractible investment, the paper analyzes the relationship between separation and the degree of under-investment.

Generic Substitution - Micro Evidence from Register Data in Norway

The importance of prices, doctor and patient characteristics, and market institutions for the likelihood of choosing generic drugs instead of the more expensive original brand-name version are examined. Using an extensive dataset extracted from The Norwegian Prescription Database containing all prescriptions dispensed to individuals in February 2004 and 2006 on 23 different drugs (chemical substances) in Norway, we find strong evidence for the importance of both doctor and patient characteristics for the choice probabilities. The price difference between brand and generic versions and insurance coverage both affect generic substitution. Moreover, controlling for the retail chain affiliation of the dispensing pharmacy, we find that pharmacies play an important role in promoting generic substitution. In markets with more recent entry of generic drugs, brand-name loyalty proves to be much stronger, giving less explanatory power to our demand model.

Strategic responses to frontier-based budget allocation: Implications for bureaucratic slack

This paper analyzes the effect on bureaucratic slack of letting a sponsor apply a simple frontier-model in the budgetary process. The relationship between the sponsor and the bureaus is described within a simple game theoretic framework in which the sponsor is given the option of utilizing the frontier-technology when allocating a fixed budget to the bureaus. The effect on bureaucratic slack is shown to be ambiguous. However, conditions under which the sponsor benefits from applying the frontier-model are identified. It is also shown that collusion between bureaus does not destroy the possible benefit of applying the frontier-model.

Regulation with wage bargaining

In many regulated industries labour unions are strong and there is clear empirical evidence of labour rent-sharing. In this Paper, we study optimal regulation in a model in which wages are determined endogenously by wage bargaining at the firm level. A seemingly robust conclusion, at least when worker bargaining power is considerable, is that incentives for cost efficiency should be stronger than in the standard case in which wages do not depend on the regulatory regime.

Regulation of Quality and the Ratchet Effect: Does Unverifiability Hurt the Regulator?

The paper considers a regulatory relationship in which the quality of the output produced by the firm may be hard to verify. When the regulator‘s commitment power is unlimited, one finds that unverifiability always hurts the regulator. Here it is shown that this need no longer be the case if the regulator‘s commitment power is limited. If unverifiability makes the regulator offer low-powered incentive schemes, the firm‘s rent from having private information about the technology is reduced. In long-term relationships, such a reduction in the information rent mitigates the ratchet effect, and by means of numerical examples it is shown that this positive effect of unverifiability may dominate the standard static cost of unverifiability.

Ownership and Cost‐Sharing Contracts

We discuss the relative merits of public and private ownership in an incomplete contract framework developed by Hart, Shleifer and Vishney (HSV). We add two new elements to their model. First, the government may offer cost‐sharing contracts when procuring the good. Second, the owner of a private firm may divert resources that increase their own profit/utility but increase total costs. The cost sharing contract allows the government to reduce the private firms incentives to dump quality in order to save on costs. However, this also leads to resource diversion, which increases total costs. We derive the preferred mode of ownership when the government optimally chooses the power of the cost sharing scheme. We find that the presence of quality‐reducing cost reductions only favours government ownership if the scope for resource diversion is substantial. A discussion of when resource diversion is likely to be important is also provided.