DP7088 Toc 'n' Roll: Bargaining, Service Quality and Specificity in the UK Railway Network

Author(s): Gianni De Fraja , Emanuela Michetti , Piercarlo Zanchettin

Publication Date: December 2008

Keyword(s): Incomplete contracts , Network regulation , Railways , Relation specific investment

JEL(s): D2 , L1 , L5 , L92

Programme Areas: Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP7088.asp.asp

The paper studies the regulatory design in a industry where the regulated downstream provider of services to final consumers purchases the necessary inputs from an upstream supplier. The model is closely inspired by the UK regulatory mechanism for the railway network. Its philosophy is one of vertical separation between ownership and operation of the rolling stock: the Train Operating Company (TOC) leases from a ROlling Stock COmpany (ROSCO) the trains it uses in its franchise. This, we show, increases the flexibility and competitiveness of the network. On the other hand, it also reduces the specificity of the rolling stock, thus increasing the cost of running the service, and the TOC's incentive to exert quality enhancing effort, thus reducing the utility of the final users. Our simple model shows that the UK regime of separation may indeed be preferable from the point of view of welfare.