Y.-S. Park, B.-H. Ahn International Review of Economics and Finance 8 1999 183–198 187
q
i
w 5 a 2 c 1
[3 1 bs
i
2 2]w 2 c 3 1 bb
for i 5 1,2. 7
To solve for the equilibrium at the first stage bargaining stage, inserting Eq. 7 into Eq. 6 gives reduced-form profit functions p
i
w of stage 1. Then, firm i’s preferred interconnection price, w
i
, is given by solving w
i
P argmax
w
p
i
w 8
s.t. c w
i
p w
i
, for i 5 1,2 and the first- and second-order conditions of optimization yield
w
i
5
5
c ,
a 1 c2, if
if 0 s
i
Sb S
b , s
i
1 for i 5 1,2
9 where Sb
; 41 1 b3 1 b
2
. Note that 0 Sb 12 and S9b 0 for |b| 1.
13,14
In general, high interconnection price implies high profit in upstream activity but low profit in downstream, and vice versa. Hence, in choosing an interconnection price,
a firm should balance the profitability from upstream and downstream operations and its preferred target is effectively determined by how much equity shares it hold.
To illustrate, in case that the firms compete a la Cournot b 5 0, the threshold value is S0 5 44.4. That is, a firm which owns more than 44.4 of total equity shares
would prefer upstream to downstream business and wish to set the interconnection price accordingly highly, and vice versa.
15
Once each firm’s preferred interconnection price is determined as in Eq. 9, it seems reasonable to suppose that the realized interconnection price, w, is an outcome
of a bargaining procedure. To keep the analysis as simple as possible, we assume that w
can be expressed as a weighted average of w
i
’s. That is to say, w 5 aw
1
1 1 2 aw
2
10 where 0 a 1 is a bargaining weight of firm 1. In the next section, we shall consider
several alternative bargaining scenarios which unambiguously fix a in Eq. 10. These include symmetric bargaining power, linear bargaining power and extreme bargaining
power scenarios.
3. Comparison of equilibrium outcomes
3.1. Symmetric bargaining power scenario To begin with, we consider the case where equal weight is given to each firm’s
preference regardless of the equity share holdings [a 5 12 in Eq. 10]. We call this symmetric bargaining power scenario and it is straightforward to obtain the realized
interconnection price and associated social welfare, which are summarized in the second column of Table 1 below.
It is interesting to find that realized interconnection price is lower and hence social welfare is higher when there are large asymmetries in the two firms’ equity shares.
16
→
Y.-S. Park,
B.-H. Ahn
International
Review of
Economics
and Finance
8 1999
183–198 Table 1
Equilibrium outcomes of joint ownership under several bargaining scenarios Symmetric bargaining power
Linear bargaining power Extreme bargaining power
Equity share of firm 1 a 5 12
a 5 s
1
a 5 1, if s
1
12, 0 otherwise Realized
for 0 s
1
Sb a 1 3c4
[1 2 s
1
a 1 1 1 s
1
c]2 a 1 c2
interconnection for Sb , s
1
, 1 2 Sb a 1 c2
a 1 c2 a 1 c2
price for 1 2 Sb s
1
1 a 1 3c4
[s
1
a 1 2 2 s
1
c]2 a 1 c2
Social welfare for 0 s
1
Sb 119 1 66b 1 7b
2
K [33 1 b
2
2 2s
1
b
2
1 K
[123 1 b
2
] 2b 2 3 2 s
2 1
1 2 b
2
] K
[33 1 b
2
] for Sb , s
1
, 1 2 Sb K
K K
for 1 2 Sb s
1
1 119 1 66b 1 7b
2
K [162 1 b 2 4s
1
1 2 K
[123 1 b
2
] b
2
2 s
2 1
1 2 b
2
]K [33 1 b
2
] K
; 3a 2 c
2
8b.
Y.-S. Park, B.-H. Ahn International Review of Economics and Finance 8 1999 183–198 189
This can be explained as follows: When the two firms’ equity shares are not different too much from each other s
1
P Sb, 1 2 Sb, upstream market becomes more
attractive to both of them than downstream. Accordingly, they might well prefer cozy pie-splitting in upstream to cumbersome competition in downstream through the
setting of high interconnection price [w
1
5 w
2
5 a 1 c2 in Eq. 9], at the expense of consumers. In this case, the setting of interconnection price can be understood as
an instrument of collusion in the absence of any outright coordination between the firms.
On the other hand, if the two firms’ equity shares are sufficiently different from each other, there arises a conflict between the firms’ interests. A firm with small share,
say firm 1 s
1
P [0,Sb], would try to lower the interconnection price as much as
possible [w
1
5 c in Eq. 9], whereas firm 2 with high share s
2
P [1 2 Sb,1] will
try exactly the opposite [w
2
5 a 1 c2 in Eq. 9]. As a consequence, realized interconnection price will be lower than that under collusion, which is certainly benefi-
cial to society. 3.2. Linear bargaining power scenario
Alternatively, imagine a situation where each firm’s equity share exactly reflects its bargaining power. That is to say, a firm with more equity shares might possess
higher voice at the bargaining table for the common interconnection price. We call this a linear bargaining power scenario, in which a 5 s
1
. The realized interconnection price and associated social welfare can be similarly calculated as under symmetric
bargaining power case, which is presented in the third column of Table 1. The qualita- tive result that asymmetric equity shares are desirable is the same as before.
17
However, in this scenario, a low share firm that prefers low interconnection price would always
be given weaker power in affecting the realized interconnection price. Hence, realized interconnection price is decreasing resp. increasing and associated social welfare is
increasing resp. decreasing for s
1
P [0,Sb] resp. for s
1
P [1 2 Sb,1].
3.3. Extreme bargaining power scenario: Majority rule Finally, imagine an extreme situation to which majority rule applies. In this case,
it is obvious that realized interconnection price will always remain at its highest level since the high share firm with exclusive control authority under majority rule always
prefers high interconnection price. Thus, social welfare will always be at its lowest level as seen in the fourth column of Table 1.
Fig. 1 below depicts the social welfares under several bargaining scenarios of JO as well as under SO which is given by Eq. 5.
3.4. Welfare comparison Now, summarizing the findings thus far allow us to have:
Proposition 1. The performance of JO depends crucially upon how equity shares are divided and which bargaining rules are employed.
190 Y.-S. Park, B.-H. Ahn International Review of Economics and Finance 8 1999 183–198
Fig. 1. Comparison of the social welfares under separate and joint ownership.
Precisely, interconnection prices and social welfares corresponding to the several bargaining scenarios of JO satisfy the following relationships. Here, SO stands for
Separate Ownership; SB for Symmetric Bargaining Power; LB for Linear Bargaining Power; and EB for Extreme Bargaining Power scenario:
w
SB
w
LB
w
EB
5 s
SO
and SW
SB
SW
LB
SW
EB
SW
SO
. Proposition 1 is the direct result of the following two observations. First, as one
moves from symmetric, through linear, to extreme bargaining power scenario, more bargaining power would be given to the high share firm. Second, high share firm will
always try to raise the interconnection price, which is detrimental to a society as a whole. Consequently, as far as welfare is concerned, it is recommendable to suppress
resp. enhance high resp. low share firm’s bargaining power as much as possible, possibly by designing an appropriate bargaining scheme. For this, the government
should assume an active role of arbitrator and listen carefully to the voice of the weaker low share firm. For instance, it may be possible for the government to affect
the rules and procedures governing the organization and operation of joint board of directors. Or in distributing initial equity shares, the composition of equity shares in
terms of common and preferred stocks could be made different between low and high share firms. In fact, symmetric bargaining power scenario can be attainable by obliging
the allocation of common stocks to be symmetric and instead the allocation of preferred stocks to be arbitrary.
Y.-S. Park, B.-H. Ahn International Review of Economics and Finance 8 1999 183–198 191
Turning to the issue of equity share allocation, we have: Proposition 2. In JO, the setting of interconnection price can be an instrument
of collusion. Hence, it is crucial to induce downstream firms to have sufficiently resp. appropriately heterogeneous equity shares in symmetric resp. linear
bargaining power scenario. In majority rule, respective equity shares are not relevant at all to social welfare.
Concerning Proposition 2, it remains to be answered whether it is possible for the government to manipulate the allocation of equity shares, thus, to induce the firms’
interests diverge. The answer can be positive as verified in the experience of electricity market privatization in the UK where the procedure for the allocation of equity shares
in the NGC was mainly dominated by other than purely economic principles. Precisely, equity shares were allocated as a sort of gift from the Secretary of State for Energy
to the RECs, which was broadly proportional to the CCA net assets of each REC as at March 31, 1989 and adjusted so that the minimum holding is 5.4.
18
To take another example, in licensing a second nation-wide local loop operator in the Korean
telecommunications market in 1997, several consortiums competed for a license and one of the important criteria for a license was the status of equity share diffusion as
well as the identity of member firms.
19,20
Now, we investigate the effect of downstream competition on the firms’ incentives in setting the interconnection price. As competition intensifies b → 21, there simulta-
neously emerge two welfare effects with opposite signs. In the first place, the loss from downstream market imperfection decreases, which is obviously beneficial to
consumers direct effect of competition. Referring to Fig. 1, this welfare-increasing effect can be represented by an upward shift of all the relevant lines and curves
including the dashed line which represents social welfare under SO, except the horizontal line which represents the welfare level under collusion.
21
At the same time, however, increased competition enhances firms’ incentives to avoid competition and
instead resort to pie-splitting, which clearly harms the consumers indirect effect of competition. Referring to Fig. 1, this is represented by the expansion of the collusive
region since S9b 0 for |b| 1. In the limit, perfect downstream competition implies perfect collusion and social welfares associated with all the bargaining scenarios
of JO drop abruptly to the point which makes JO indistinguishable from SO. The net effect of competition is not clear ex-ante, rather, depends on how the equity shares
are initially allocated and which bargaining rules are employed. To sum up, we have:
Proposition 3. In JO, the benefit of encouraging downstream competition may be crowded out by correspondingly enhanced incentive for upstream collusion,
unless equity shares and bargaining rules are appropriately adjusted.
Proposition 3 is of great importance in reality because a policy measure aimed at promoting competition tends to be blindly welcomed. Rather, in JO, a competition
policy should be well accompanied by more careful measures of avoiding collusion. Not only is the latter desirable in itself, but also it helps to fully realize the virtue of
the former measure.
192 Y.-S. Park, B.-H. Ahn International Review of Economics and Finance 8 1999 183–198
4. Discussion
