Information Economics and Policy 11 (1999) 1–22

Light-handed regulation of access in Australia:

negotiation with arbitration
Stephen P. King a , *, Rodney Maddock b
a
Department of Economics, The University of Melbourne, Parkville, Vic. 3052, Australia
b
Department of Economics, La Trobe University, Bundoora, Vic., Australia
Received 1 July 1998; accepted 23 October 1998

Abstract

Interconnection based on commercial negotiation subject to arbitration forms part of US

and Australian telecommunications legislation. General infrastructure access in Australia is
also governed by ‘light-handed’ regulation based on bargaining. This paper considers the
potential outcomes of access regulations based on negotiation. Using an infinite period
bargaining game with an outside regulatory option, we show that a range of potential
equilibria can be supported by negotiation. Access seekers and access providers may fail to
seize monopoly profits in equilibrium. The regulator can substantially influence the range of
bargaining outcomes through both the expected outcome of arbitration and its interpretation
of regulatory procedures. We consider alternative regulatory approaches consistent with the
Australian legislation. The model presented in this paper uses the Australian regime as a
template, but provides insight into the broader issue of ‘light-handed’ access regulation.
 1999 Elsevier Science B.V. All rights reserved.

Keywords: Access; bargaining; regulation; public utilities; telecommunications

JEL Classification: D43; L13; L42; L96

1. Introduction

Access is a key element in infrastructure reform. Competition in telephone

services, electricity and gas retailing, water and sewerage services and rail

* Corresponding author. Tel.:1 61-3-93447029; fax: 161-3-93446899.

E-mail address: s.king@ecomfac.unimelb.edu.au (S.P. King)

0167-6245 / 99 / $ – see front matter  1999 Elsevier Science B.V. All rights reserved.
PII: S0167-6245( 98 )00019-5
2 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

transport is often only feasible if potential competitors have access to the

underlying infrastructure facilities needed to produce the final product. For
example, it is usually uneconomic for a new electricity retailer to replicate the
distribution grid in a residential area, so that competition between retailers can
only arise if they all have access to that grid.
A wide variety of access regimes exist in different countries and industries. In
part, this is due to different technological characteristics. For example, access to a
gas reticulation system involves a different set of regulatory issues compared to
local telephone access. The former involves a ‘one-way’ flow of product from the
city gate to the customer, while the latter involves ‘all-to-all’ interconnectivity as
customers both receive and transmit calls.1 Historic circumstances may also play a
role. If electricity distributors / retailers have always been separate from the
transmission company then the appropriate rules for access may differ compared to
an integrated generation / transmission / distribution company.2
Differences in access regimes also reflect alternative intellectual positions on the
appropriate form of regulation.3 There are three broad approaches – there might be
no specific regulation, the parties might be left to negotiate between themselves
with the outside option of binding arbitration, or a regulator might set the access
price directly. In New Zealand there has been no specific access regulation in
telecommunications. When an interconnection dispute arose between Telecom
New Zealand and Clear Communications, the case was brought under the general
provisions of antitrust legislation (Blanchard, 1994). At the other extreme, many
jurisdictions have adopted ‘heavy’ handed regulation where a regulator directly
sets the access price.
A number of countries are experimenting with an intermediate ‘light-handed’
approach. Both the US Telecommunications Act of 1996 (see Huber et al., 1996)
and Australian legislation (see Maddock and Marshall, 1997) require a party which
owns a relevant facility to negotiate with an access seeker subject to either party
having the right to refer the matter to an arbitrator at any time.
The broad objective of this paper is to understand how a ‘light-handed’

1
For a discussion of local telephone access see Economides (1995), and Laffont et al. (1998a, b).
2
Since the 1950s, electricity in Australia has been provided by state-owned monopolies. Different
states have, however, had different structures. For example, New South Wales has had separate
distribution and transmission companies while Victoria has had an integrated generation / transmission /
distribution company. In recent years, the structure of some of these state electricity industries has
changed dramatically. In the mid 1990s, the state of Victoria vertically separated generation,
transmission and distribution. It horizontally separated the generation and distribution companies, and
these companies were privatized. These reforms were accompanied by significant prescriptive access
regulations. In contrast, in the state of New South Wales, there has been less restructuring and no
privatization. Regulated access rules, as a consequence, have been less prescriptive.
3
For example, a variety of different and only partially consistent access pricing rules have recently
been both promulgated and debated. See Baumol and Sidak (1994), Armstrong et al. (1996), Laffont
and Tirole (1994), and Ralph (1996). Economides and White (1995), for example, criticise the Baumol
and Sidak approach.
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 3

regulatory process will work in practice. We present a formal model of the

Australian access procedures as an instrument to examine ‘light-handed’ access
regulations. In particular, we consider the bargaining game established by
Australian legislation, the type of outcomes that are likely to arise from the
negotiated process, and how these outcomes can be influenced by the regulator.
At the simplest level, negotiated access could be expected to provide few
benefits for consumers. Both the access provider and the access seekers have
incentives to devise a set of contracts that lead to monopoly pricing for the final
product that uses access as an input. The access contracts can then be used to
divide the monopoly profits between the various producers.
This simple argument has a number of flaws. If the contracts between an access
provider and each access seeker are privately renegotiable, then the potential for
opportunistic recontracting can prevent firms from sharing monopoly profits (see
Hart and Tirole, 1990, McAfee and Schwartz, 1993 and Rey and Tirole, 1996).
Even if contracts that share monopoly profits both exist and pass standard antitrust
laws, bargaining may not be efficient. For example, asymmetric information may
potentially undermine efficient bargaining in a standard alternating offers frame-
work.
We show how the interaction between integration, bargaining and potential
regulatory intervention leads to a variety of equilibrium outcomes. The incentive
for an integrated facility owner to stall the provision of access and the ability for
either party to request compulsory intervention (albeit at the expense of total
surplus) combine to create inefficient equilibria of the bargaining game.4 The
regulator can influence the potential range of equilibrium outcomes by altering its
own strategies for intervention. Importantly, small changes in the way the
regulator interprets its duties and responsibilities can significantly affect the set of
feasible bargaining outcomes. Careful consideration by the regulator of its role as
arbitrator will be a key factor in the success or failure of ‘light-handed’ access
regulation.

2. The example of Australian regulation

The Australian regulatory framework for ‘essential facility’ access and tele-
phone network interconnection involves commercial negotiation with regulatory
intervention if requested by the relevant firms.5

4
The arbitration option under the Australian access regime is a special case of ‘money burning’ in
bargaining. As Avery and Zemsky (1994) show, multiple and potentially inefficient equilibria exist in
such bargaining games. However, unlike standard models with ‘outside options’ (for example see
Binmore et al., 1992) the Australian access regime allows both parties to always seek the outside option
and provides a continuation payment for one player in the absence of agreement.
5
Access to essential facilities is controlled by Part IIIA, and telephone interconnection by Part XIC
of the Australian Trade Practices Act.
4 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

Broadly speaking, any party can approach a national regulator (the National
Competition Council or NCC) requesting that a service provided by an infra-
structure facility be declared subject to access. Declaration involves a number of
legislative requirements.6 If a service is declared, the facility owner is required to
negotiate with any access seekers. If these negotiations are unsuccessful, then
either the (potential) access provider or the access seeker may request the
intervention of a second national regulator, the Australian Competition and
Consumer Commission (ACCC).7 The ACCC then determines the terms and
conditions of access.8 The ACCC has wide powers to set the terms and conditions
for access and in making its determination the ACCC must take account of ‘the
public interest, including the public interest in having competition in markets’
(section 44X1b). This section has been interpreted as requiring the ACCC to
pursue (at least limited) allocative efficiency as part of the arbitration / determi-
nation process (see Industry Commission (1995) and the Australian Competition
and Consumer Commission (1996)). The ACCC determination is binding on all
parties to the dispute.
The Australian regulations provide a template for the theoretical model
presented in the next section.

3. Bargaining and access

A facility owner, P, is a monopoly producer of both an upstream service and a

downstream product that uses the upstream service as an input. For example, P
may own an electricity distribution network and use this network as a monopoly
electricity retailer. We assume that the upstream service is essential for down-
stream production.9 In the absence of competition at either stage of production, the

6
For ‘essential facilities’, a ‘service’ is defined in section 44B of the Act while the declaration
requirements are set out in section 44G. The declaration criteria are similar to, but deliberately
distinguished from, the criteria that have been established by the US courts under the essential facilities
doctrine. For example, there is a test requiring access to promote competition (section 44G2a) and a test
requiring that it is uneconomical for anyone to develop another facility (section 44G2b). The legislation
attempts to avoid the breadth of the US doctrine by including a ‘national significance’ test (section
44G2c). For a more detailed discussion of the declaration procedures, see National Competition
Council (1996) and King and Maddock (1996). For a discussion of the US essential facilities doctrine,
see Areeda (1989) and Werden (1987).
7
See section 44S of the Act. Compulsory arbitration was introduced to avoid deliberate obfuscation
and delay by the access provider. Such delay was experienced, for example, with telephone
interconnection in the UK. See Vickers and Yarrow (1988).
8
Section 44V1 of the Act. Under section 44Y, the ACCC may refuse to provide an access
determination in a restricted set of circumstances, for example, if it believes that the dispute is trivial.
9
In other words, there are no substitutable inputs so a fixed quantity of the upstream service is
required per unit of downstream product.
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 5

facility owner generates monopoly profits from its integrated operations. These
profits are denoted by p m per period.
A second firm, S wishes to compete in the final product market.10 The access
provider P and the access seeker S must negotiate the terms and conditions of
access subject to regulatory intervention if requested by either firm. Intervention
will lead to a binding determination that will provide per period profits of p dp to
the facility owner and p sd to the access seeker. We assume that there are no gains
in productive efficiency from the provision of access so that p dp 1 p sd # p m .11
Negotiating an access agreement is equivalent to bargaining over a distribution
of final product profits. We assume that P and S can potentially seize and divide
monopoly profits so the potential per period profits for P and S are given by hpp ,
ps j subject to pp 1 ps # p m . This requires (i) that S is as efficient as P in
downstream production; (ii) that there are no variable costs of access in addition to
upstream production costs; and (iii) that there are no relevant, unavoidable
constraints on contracts between S and P, say, under standard antitrust laws.12
Fig. 1 illustrates the potential set of bargaining outcomes. In any period where
neither a negotiated access regime nor a binding determination is in place, the
monopoly facility owner receives profits p m . If a negotiated settlement has been
reached then P and S receive agreed profits pp and ps respectively, with joint
profits bounded by monopoly profits p m . Regulatory intervention is represented by
(p dp , p ds ). As drawn, p dp 1 p ds , p m .
The potential conflict between the access provider and access seeker, and the
role of the regulator are highlighted by Fig. 1. If the firms agree on a negotiated
access regime, then it is in their mutual interest to secure monopoly profits. The
facility owner, however, has an incentive to stall negotiations. Any negotiated
outcome will be weakly dominated by continued monopoly from P’s perspective.
To prevent stalling, the access seeker must be able to credibly call for regulatory
intervention, but in general this will lead to a reduction in total profits. It is in the
interest of both firms to avoid intervention. As shown below, the trade-off between

10
We consider the case where P is vertically integrated and there is only a single access seeker S.
This simplifies the bargaining problem and eliminates the issue of renegotiation with multiple access
seekers considered, for example, by Rey and Tirole (1996).
11
If there were productive efficiency gains–for example if S was a more efficient producer of the
final product than was P – then these gains should already have been exploited. For example, P could
have contracted out production to S.
12
For (ii), access will often involve a one-shot fixed investment (e.g. for telecommunications access,
building new and / or modifying existing switches). In this case, the monopoly profits are the variable
per period profits available to the firms. For (iii), the contracts between S and P may involve non-linear
prices or fixed quantities with transfers between the firms. A contract, for example, that involved a
payment from P to S with a quantity restraint on access purchases by S may raise concerns under
standard antitrust laws. If so, we assume that S and P can avoid antitrust violation, for example, by
using side contracts to transfer relevant funds. Payments may be hidden as a commercial contract where
P buys a product from S at a highly inflated price. These assumptions eliminate a number of potentially
interesting issues in contracting, but these issues are orthogonal to the main focus of this paper.
6 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

Fig. 1. The potential bargaining outcomes.

obfuscation and interventionist brinksmanship may result in negotiated outcomes

that do not simply share monopoly profits between the firms. The potential range
of these outcomes will be influenced by the (predicted) outcome of regulatory
intervention as represented by (p dp , p ds ).

3.1. The bargaining process

Interaction between P, S and the regulator is modelled in a standard alternating

offers bargaining framework (see Rubinstein, 1982). Bargaining proceeds over a
(potentially infinite) number of periods. In each period one firm makes an offer of
terms for access. An offer involves an access contract, but is represented by the
division of per period profits that would be achieved if the contract was accepted
(pp , ps ).13 The other firm can either accept or reject the offer. If an offer is
13
More formally, (pp , ps ) represents the average per period payoffs from acceptance. If acceptance
of the offer in period T leads to a payoff path p ti , t[hT, T 11, . . . j, i [h p, sj then the average payoff
to i is pi 5(12d ) o `t 5 T d t 2 T p it where d is the common discount factor. Non-stationary payoffs
increase the range of access contracts available to the firms. Clearly, pp 1 ps # p m .
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 7

accepted then it begins in the current period and continues indefinitely. If an offer
is rejected then the firms individually and simultaneously decide whether or not to
call for regulatory intervention. Either firm can unilaterally call for intervention
and such a decision is irreversible. The access determination that results from
intervention commences in the next period. If neither firm calls for intervention
then the bargaining process recommences in the next period.
Firms alternate between ‘offeror’ and ‘acceptor’. For convenience, we com-
mence bargaining in period one with P making the initial offer. Bargaining
proceeds with P making offers in odd periods and S making offers in even periods.
So long as neither an agreement nor a determination has commenced, P receives
monopoly profits each period during the bargaining process. The two firms have
an identical discount factor denoted by d.
Regulatory lag is represented by the delay between a firm calling for interven-
tion and an access determination. Unlike a negotiated settlement, regulatory
procedures may involve formal hearings and may be subject to appeal. Even if one
firm immediately calls for intervention, the facility owner will still enjoy at least
one period of monopoly profits. The average per period profits for P and S under
immediate intervention are given in Fig. 1 by (p m (1 2 d ) 1 dp dp , dp sd ).14 As either
firm can call for immediate intervention, these payouts provide a lower bound on
the average equilibrium payouts for each firm.
Access negotiations resemble a class of bargaining problems analyzed by
Shaked and Sutton (1984) and Avery and Zemsky (1994) where one player can
invoke an outside option after disagreement.15 In the regulatory model presented
above either firm can choose the terminal option of regulatory intervention. Busch
and Wen (1995) also analyze a related problem where the bargaining parties play a
stage game in each period of disagreement. The stage game in access bargaining is
trivial – P receives p m and S receives nothing.16

3.2. Preliminary results

Two results immediately follow from the model. First, seeking intervention is a
weakly dominated strategy for the access provider. P receives monopoly profits
when bargaining is delayed and cannot be made worse off by delaying interven-
tion. Secondly, if a regulatory determination simply divides monopoly profits then
immediate intervention is efficient from the firms’ perspective. S can do neither
better nor worse than call for immediate intervention and this is reflected in the
unique subgame perfect equilibrium payoffs.

14
In other words, P receives one period monopoly profits and then p dp forever while S receives p ds
forever, commencing in the second period.
15
For a survey of related literature, see Binmore et al. (1992) and Osbourne and Rubinstein (1994).
16
The model considered by Busch and Wen does not involve a terminal outside option.
8 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

These two results are summarized below. As with all other results, the formal
proofs are in Appendix A.

Result 1. Seeking intervention is a weakly dominated strategy for player P.

Result 2. Suppose p ds 1p pd 5p m . Then the unique subgame perfect equilibrium

average payoffs from the bargaining game are (p m (1 2 d ) 1 dp dp , dp ds ).

Result 1 allows us to focus on equilibria where only S ever threatens to seek

intervention. From Result 2, we restrict attention to situations where regulatory
intervention reduces total profits below monopoly profits.
Regulatory intervention places a lower bound on the payoffs for each firm.
There may not, however, be equilibria that sustain these payoffs. Result 3 shows
that if the firms are sufficiently patient then there are subgame perfect equilibria
commencing in even periods that lead to the lowest possible average payouts for
each firm.

Result 3. If d 2 . p sd /(p m 2 p pd ) then there exists a subgame perfect equilibrium

commencing in even periods which gives S an average payout of dp sd . There is
also a subgame perfect equilibrium commencing in even periods that gives P an
average per period payout of (1 2 d )p m 1 dp pd .

S can avoid continual obfuscation by P because of the threat to call for

intervention after P rejects an offer. This reflects the Australian access regime
which allows either party to seek regulatory intervention at any time. In contrast, if
S could only seek regulatory intervention after rejecting an offer from P, the
unique average payoffs would be (p m 2 dp ds , dp ds ).17

4. Outcomes of access bargaining

4.1. Bargaining with patient players

To analyze the potential subgame perfect equilibria of the access bargaining

game, consider that (i) both firms are relatively patient so that Result 3 is valid and
(ii) the equilibrium involves immediate agreement.18 The equilibria characterized
by Result 3 provide the lowest possible payoffs to each firm from the second
period onwards. In equilibrium for the complete game, the access provider cannot
receive less than the equivalent of one period of monopoly profits followed by his
worst payoff in period 2. The access seeker, however, would prefer to call for

17
See Osbourne and Rubinstein (1994).
18
We consider ‘impatient’ players and agreement with delay below.
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 9

immediate intervention rather than receive the worst possible period 2 payoff and
the determination payoffs will directly provide a lower bound on the payoff to the
access seeker. All feasible combinations of profits that exceed these lower bounds
will be sustainable in equilibrium for patient firms.

Proposition 4. If d 2 . p ds /(p m 2 p dp ) then there exist subgame perfect equilibria

which support payoffs (x, y) in period one where

x [ [(1 2 d 2 )p m 1 d 2 p pd ,p m 2 dp sd ],

y [ [dp sd , d 2 (p m 2 p pd )]

and

x1 y#pm

Further, no equilibria exist which give average payouts which are not within this
range.

The set of average profits supportable as equilibrium outcomes of the access

bargaining game under Proposition 4 is shown in Fig. 2
Two results follow immediately from Proposition 4. First, even though the
access seeker and access provider always have available contracts that lead to any
division of monopoly profits, the firms may agree to an access contract that leads
to less than monopoly profits. Each firm rationally believes that any attempt to
gain a larger level of total profits will individually make it worse off. Such
outcomes are not ‘renegotiation proof’, but highlight the complexity of the
bargaining problem. Although both parties have every incentive to share monopoly
profits, this may not occur in equilibrium.
Secondly, Proposition 4 defines the set of possible average equilibrium payoffs
for any subgame (including the entire game) beginning in an odd period. The
strategies used to prove the proposition, however, are not unique. While these
strategies involve immediate agreement, it is trivial to see that equilibria involving
some delay are also supportable.19 Delay does not imply either a diminution in
total profits or a loss to the access seeker. Rather, it shifts the allocation of profits
over time with the facility owner gaining a greater share of profits up front while
the access seeker only gains a share of the profits after agreement is reached.

19
For example, in equilibrium S and P could disagree for two periods then agree to a division of
profits (x, y) where x5(12d 2 )p m 1d 2 p pd and y5d 2 (p m 2 p dp ). This leads to average profits of
(12d 4 )p m 1d 4 p dp for P and average profits of d 4 (p m 2 p dp ) for S over the whole game. So long as S’s
profits exceed dp ds , then it is easy to construct complete strategies, such as those used in the proof of
proposition, that support these actions in equilibrium.
10 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

Fig. 2. The set of equilibrium outcomes.

4.2. Bargaining with impatient players

For low values of d the access seeker will always seek intervention, if it has the
opportunity, in the second period. The analogue of Result 3 is given by the
following.

]]]]
Result 5. For d ,œp ds /(p m 2 p dp ) the unique average equilibrium payouts of a
subgame beginning in any even period is (p m (1 2 d ) 1 dp dp , d (p m 2 p dp )).

If firms are impatient, either the access seeker or the facility owner negotiates
from a position of strength. At very low levels of d, S cannot credibly commit not
to pursue immediate regulatory intervention and P can seize all profits above those
that S would gain from an immediate determination. For higher levels of d, the
access seeker will seek arbitration in the second rather than the first period. The
access seeker can make a minimal offer to P in the second period, credibly
threatening to call in the regulator if that offer is rejected. This bargaining power
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 11

feeds back into the first negotiation period leading to either immediate settlement
or a one-period delay.

]]]]
Proposition 6. For d [ (p ds /(p m 2 p dp ), œp ds /(p m 2 p dp )) the unique subgame
perfect average payoffs are ((1 2 d 2 )p m 1 d 2 p pd , d 2 (p m 2 p pd )). For d [ [0,
p sd /(p m 2 p pd )] the unique subgame perfect average payoffs are (p m 2 dp sd , dp sd ).

Proposition 6 highlights two important regulatory issues. First, at low levels of

d, bargaining will always result in a simple division of monopoly profits.
Secondly, while the value of d is exogenous to the access seeker and the facility
owner, the regulator can manipulate this value through the expected determination
outcome. More generally, regulatory discretion can influence the potential
outcomes of access bargaining. We turn to this issue in the next two sections.

5. Regulatory intervention and procedural discretion

The regulator will often have considerable discretion over the procedures for
dealing with access disputes. For example, under the Australian legislation, the
regulator may refuse to establish an access contract if the party who notified the
dispute has not previously negotiated in good faith (s44Y1c).
In this section we consider the implications of procedural discretion through

‘Last chance’ bargaining: the regulator requires that parties continue to

negotiate for a fixed number of periods after an access dispute is notified;
Minimum bargaining time: the regulator can refuse a dispute notification
unless bargaining has occurred for a minimum number of periods; and
‘Biased’ determinations: the regulator can implicitly or explicitly favor either
the party who brings the access dispute or the other party to the dispute.

The regulator can choose these options either directly through the legislation (e.g.
interpreting ‘good faith’ negotiations to require a minimum bargaining time) or
through its discretion to balance the interests of the access provider, access seeker
and the public interest in a determination.

5.1. ‘ Last chance’ bargaining

A ‘last chance’ bargaining rule guarantees that there are unique subgame perfect
equilibrium payoffs from access negotiations that perfectly divide monopoly
profits. Either P or S will always call for intervention at the first available
12 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

opportunity.20 By creating a known termination date for bargaining, intervention

places all the negotiating power in the hands of the firm that makes the last offer.
Although P gains relative to S through increased regulatory delay, either P or S
will be able to push the other firm to its worst possible payoff.

Result 7. Suppose a firms calls for intervention in period t and ( i) firms must
continue to negotiate for up to T periods; ( ii) if agreement is reached at or before
period t 1 T, then the agreement binds the parties and ( iii) if the parties do not
agree at or before period T 1 t then they receive the per period determination
payoffs (p dp ,p ds ) from T 1 t onwards. Then if T is odd, the unique subgame perfect
equilibrium average payoffs of the bargaining game are given by (p m (1 2 d T ) 1
d T p pd , d T (p m 2 p pd )). If T is even then the unique subgame perfect equilibrium
average payoffs of the bargaining game are given by (p m (1 2 d T ) 1 d T (p m 2
p ds ), d T p ds ).

5.2. Minimum bargaining times

Suppose the regulator requires the firms to negotiate for at least T periods before
it will consider an access dispute. This delay will benefit the access provider but
have few other effects. Bargaining will be equivalent to P receiving T21 periods
of monopoly profit with negotiations commencing in period T. Subgame perfection
implies the following corollary.

Corollary to Result 3 and Proposition 4. Suppose it is impossible to call for

arbitration until period T and that d 2 . p ds /(p m 2 p dp ). If T is even then there
exist subgame perfect equilibria which support payoffs (x e , y e) in period 1 where
x e [ [p m (1 2 d T ) 1 d T p dp , p m 2 d T p ds ], y e [ [d T p ds , d T (p m 2 p dp )] and x e 1 y e #
p m . If T is odd then there exist subgame perfect equilibria which support payoffs
(x o , y o) in period 1 where x o [ [(1 2 d T 11 )p m 1 d T 11 p dp , p m 2 d T p ds ], y o [
[d T p sd , d T 11 (p m 2 p pd )] and x o 1 y o # p m . Further, no equilibria exist which give
average payouts which are not within this range.

5.3. ‘ Biased’ determinations

The regulator may be able to ‘reward’ or ‘punish’ a firm which brings an access
dispute. This policy need not be explicit, so long as both firms understand how a
determination will depend on the party which brings the dispute to the regulator.

1. ‘Punish’ the party bringing an access dispute. Suppose that the determination
payoffs are given by (p dp 1 ´, p ds 2 ´) when S unilaterally seeks regulatory

20
Noting that, in equilibrium, the firms may settle immediately so that this opportunity may never
occur.
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 13

intervention; (p dp 2 ´, p ds 1 ´) when P unilaterally seeks intervention and (p dp , p ds )

if both firms simultaneously seek intervention. Seeking intervention remains a
weakly dominated strategy for P, so in equilibrium only S will ever seek
intervention. Consequently, Proposition 4 is unaffected, except that the de-
termination payoffs are given by (p dp 1 ´, p ds 2 ´).

2. ‘Reward’ the party bringing the access dispute. Suppose that the de-
termination payoffs are given by (p dp 2 ´, p ds 1 ´) when S unilaterally seeks
regulatory intervention; (p pd 1 ´, p sd 2 ´) when P unilaterally seeks intervention
d d
and (p p , p s ) if both firms simultaneously seek intervention.
Calling for intervention is no longer a weakly dominated strategy for P and P
will want to call for intervention if it believes that S is also about to seek
intervention. For ´ ‘small’, there will be no change in the range of outcomes
supportable in equilibrium for patient firms, although equilibrium strategies will
change. Also, the critical value of d that separates patient from impatient firms
will fall.

Result 8. Suppose the regulator follows a policy of rewarding a unilateral

complainant by ´ while simultaneously punishing the other player by ´ in any
determination. If
d . (p ds 1 ´) /(p m 2 p pd )
and
´ , (p m 2 p pd )(1 2 d )
then there exist subgame perfect equilibria which support payoffs (x, y) in period
one where x [ [(1 2 d 2)p m 1 d 2 p dp , p m 2 dp sd ], y [ [dp sd , d 2 (p m 2 p pd )] and
x 1 y # p m . Further, no equilibria exist which give average payouts which are not
within this range.

‘Rewarding’ the party that brings an access dispute means that firms will
simultaneously call for regulatory intervention in equilibrium. This, in turn,
reduces the benefits from unilateral deviation, making it ‘easier’ to support a
variety of equilibria. This is reflected in Result 8, and if ´ is positive but arbitrarily
small the entire range of average payoffs shown in Fig. 2 are supportable in
equilibrium if d . p ds /(p m 2 p dp ). This contrasts with Proposition 4 which
required d 2 . p sd /(p m 2 p pd ).

6. Discussion

‘Essential facility’ access and interconnection regulations based on commercial

negotiations are being discussed in a variety of countries. In this paper we have
14 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

explored the particular Australian legislation to throw light on the broader

regulatory issues. We note that these regulations appear to provide strong
incentives for negotiating firms to seize monopoly profits through the pricing of
the essential input, although this may be infeasible if relevant contracts are
unavailable, either due to standard antitrust laws or the ability of some firms to
engage in secret renegotiation.
In this paper we have shown that, even when the full range of contracts are
available and there is only a single access seeker, the complexity of the bargaining
problem means that the access seeker and facility owner may not agree on a
contract which simply divides monopoly profits. Rather, bargaining may lead to a
dissipation of monopoly profits with the lower bound for the potential bargaining
outcomes dependent on the predicted result of regulatory intervention. If, however,
the firms are relatively impatient then bargaining will always lead to a division of
monopoly profits.
While intervention does not occur in equilibrium, the regulator has a critical role
in the negotiation process. By altering firms’ expectations about the outcome of
intervention, the regulator can manipulate the lower bound of the bargaining set
for patient firms. The regulator can also influence the critical ]]]]
discount rate that
separates patient and impatient firms. This discount rate, œp ds /(p m 2 p dp ), is
increasing in both p ds and p dp . The regulator can increase the potential range of
bargaining outcomes and maximize the likelihood that firms will be ‘patient’ by
decreasing firms’ expectations about the outcome of regulatory intervention.
The regulator also plays a crucial role through regulatory procedures. We have
examined three procedural approaches that can be adopted by the regulator. First,
the regulator can require bargaining to continue for a fixed period after interven-
tion is requested. Such ‘last chance’ bargaining increases the ability of firms to
agree to seize monopoly profits by short-circuiting the incentive for the access
provider to stall negotiations.
Secondly, the regulator may require the parties to bargain for a fixed length of
time before it will consider a request for intervention. In contrast to ‘last chance’
bargaining, this minimum bargaining time simply increases the incentives for the
access provider to stall negotiations as it is now guaranteed a fixed period of
continued monopoly profits before intervention is possible.
Thirdly, the regulator may slightly favor either the firm that seeks intervention
or the other firm. This favoritism may be implicit or explicit. Indeed, it may not
even be formally recognized by the regulator but simply be imbedded in market
perceptions about regulatory intervention.
When the regulator favors the firm who does not bring an access dispute, then
access negotiations are largely unchanged. In contrast, if the regulator favors the
firm that seeks intervention, the set of potential equilibrium outcomes for patient
firms is unchanged, but the range of firms that will be considered ‘patient’
increases. In other words, it becomes easier to support equilibria that involve a
reduction in total profits below monopoly levels.
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 15

To move from these results to a formal welfare analysis requires the additional
assumption that social welfare is rising as total profits fall below monopoly levels.
The maximum potential welfare from access negotiations is then raised if the
regulator takes a strong anti-profit approach to intervention and if the regulator
tends to favor both early recourse to intervention and the firm that seeks
intervention.
Other factors may offset the desirability of a strong regulatory stance. Our
results describe the complete set of possible equilibrium outcomes but cannot
show which outcomes are more likely. It is possible that a change in firms’
expectations about intervention will alter the relative probability of different
equilibrium outcomes. Such analysis would require a model of equilibrium
selection and is beyond the current model.
Our analysis focuses on the range of bargaining outcomes. These are dependent
on the specific framework chosen to model the bargaining process. The model we
have used extends recent literature on bargaining and captures the underlying
regulatory framework established by legislation in Australia. In particular, the
model captures the tensions between obfuscation and intervention that characterize
access bargaining.
As noted above, we have simplified our analysis by assuming that the full range
of contracts to seize any relevant level of profit are available to the firm. If the set
of available contracts is limited then our results will be modified. The relationship
between the regulator and access negotiations in such circumstances provides
scope for further research.

Appendix A

Proof of Result 1. Consider strategies ss and sp for firms S and P which involve
P calling for regulatory intervention at period t with positive probability. If ss
involves S calling for intervention at t then P is indifferent between also calling
for intervention at t or deviating. If ss involves S not calling for intervention at t
with positive probability then it will always pay P to deviate from calling for
intervention at t. At worst, such a deviation will either be irrelevant if S does call
for intervention at t, or will lead to the worst possible equilibrium punishment for
P commencing in period t11 if intervention is avoided at t. But this worst
equilibrium involves P receiving a flow of payments worth no less than p m 1
dp m 1 d 2 p dp /(1 2 d ) in present value terms at t while immediate intervention
leads to p m 1 dp pd /(1 2 d ). As p pd # p m , P always weakly prefers to deviate.
Thus, for any ss , P weakly prefers to deviate from sp at time t, so this strategy is
weakly dominated for P. h

Proof of Result 2. Consider any strategies that involve different average payouts.
Then one or other party must be receiving a lower payout than in their worst
16 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

punishment equilibrium so it will always pay at least one party to deviate. To show
that the payouts can be supported as a subgame perfect equilibrium is trivial. h

Proof of Result 3. First assume that there exists an equilibrium commencing in

even periods which gives P an average payout of (1 2 d )p m 1 dp pd and gives S an
average payout of d (p m 2 p pd ). Denote the equilibrium strategies by s sp and s pp
for S and P respectively. To show the equilibrium beginning in even periods
which gives S an average payout of dp ds exists consider the following strategies
for P and S respectively:

s sp At every even period, if S offers at least p m 2 dp ds , then accept, otherwise

reject. In each successive odd period offer (p m 2 p sd , p sd ). If observe an
own deviation in an odd period then play s pp commencing in the next
period. Ignore any other deviations.
s ss In each even period offer (p m 2 dp ds , dp ds ). In each successive odd period
accept an offer of at least p sd . If offered less than this, reject and play s sp
commencing in the next period. Never seek arbitration in an even period
but if reject an offer of at least p ds in an odd period, seek arbitration.
Ignore any other deviations.

To check that this is an equilibrium consider that an odd period is reached. If P

offers at least p ds he expects it to be accepted. If he offers less then he expects to
be rejected and punished. As the present value of deviation and punishment is
p m 1 dp m 1 d 2 p dp /(1 2 d ) while offering p ds yields (p m 2 p ds ) /(1 2 d ), he
prefers not to deviate so long as d 2 . p ds /(p m 2 p dp ). Note also that under this
same condition S would prefer to reject an offer less than p ds as the average payout
from punishing P exceeds this value. If S receives an offer of at least p sd then she
prefers to accept this offer rather than go to arbitration as she receives an average
payout of dp ds under this option. Finally, if S rejects the offer then she strictly
prefers arbitration to waiting for the next even period given the range of d. Thus no
player will deviate in an odd period.
Now, consider any even period. If P is offered at least p m 2 dp sd then he is at
least as well off by accepting this offer as waiting until the next odd period.
However, he prefers not to accept any lower offer. If S has their offer rejected then
she is indifferent between seeking arbitration and waiting until the next odd
period. Thus she has no incentive to deviate and will not seek arbitration. She also
has no incentive to offer less to P as this will be rejected, leaving her no better off
than if she followed the equilibrium strategy. Thus no player will deviate in an
even period. As no player will ever deviate, the strategies form an equilibrium.
Second, we need to show that there exists an equilibrium commencing in even
periods which gives P an average payout of (1 2 d )p m 1 dp pd and S an average
payout of d (p m 2 p dp ). To see this, denote the relevant even period as t52 and
consider the strategies:
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 17

s pp At t52 accept an offer of at least (1 2 d )p m 1 dp dp . Otherwise reject. If

no agreement or arbitration by t53 then play s ps .
s ss At t52 offer ((1 2 d )p m 1 dp pd , d (p m 2 p pd )). If have the opportunity at
t52, go to arbitration. If reach period t53 without agreement or
arbitration, play s ss .

To check that this is an equilibrium, note that if S ever gets to choose arbitration
at t52 then she will be indifferent and will have no incentive to deviate. Failure to
call in the regulator will lead to her being ‘punished’ with an average payout of
dp ds , which is the same as the average payout from arbitration. Knowing this, it
will pay P to accept any offer of at least (1 2 d )p m 1 dp dp . It then pays S to offer
no more than this. Thus, no player will deviate and (s ss , s sp ) and (s ps , s pp ) form a
pair of mutually supporting equilibrium strategies for d 2 . p sd /(p m 2 p pd ). h

Proof of Proposition 4. For any (x, y) that satisfies the restrictions given in the
proposition, consider the following strategies.

[sp ] At t51 offer (x, y). If reach t52 and did not offer (x, y) at t51 then play
s pp . If reach t52 and did offer (x, y) at t51 then play s sp .
[ss ] At t51 accept offer (x, y). Reject any other offer and do not seek
arbitration. If deviate and reject (x, y), call for arbitration. If reach t52
and P did not offer (x, y) at t51 then play s pp . If reach t52 and P did
offer (x, y) at t51 then play s ps .

From Result 3, no player will deviate from t52 onwards. To show that no
player will deviate at t51 note that if P makes any other offer then they expect it
to be rejected and to be punished in period two. As the return from deviation and
punishment cannot exceed x, player P prefers not to deviate. For player S, note
that they will never prefer to accept a deviant offer from P rather than to reject
such an offer and punish P. Punishment yields an average payoff of d 2 (p m 2 p pd )
to S which is as least as great as any deviation offer from P that makes both P and
S weakly better off than (x, y). Finally, note that if S rejects (x, y) then they expect
to be punished at period two. S strictly prefers arbitration to this punishment. Thus,
no player will deviate in any period and sp and ss form an equilibrium with
average payout (x, y).
Next, we need to show that there is no equilibrium that supports average
payouts not included in the set described by the proposition. Consider that such an
equilibrium exists. No subgame of the equilibrium can involve an average payout
to S of less than dp ds or it would pay S to deviate and seek arbitration. But, as no
subgame can have such an average payout, nor can the negotiation game as a
whole. Also, no subgame beginning in an odd period can involve an average
payout to P of less than (1 2 d 2 )p m 1 d 2 p pd or it would pay P to deviate and
18 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

make an offer which gives P at least (1 2 d 2 )p m 1 d 2 p dp and S more than dp ds .

Such a deviation is always possible given the restriction on d and, at worst, could
either lead to rejection and punishment beginning in the next odd period, rejection
by S and arbitration, or acceptance. Clearly acceptance means that the deviation is
desirable. Rejection and arbitration is a strictly dominated strategy for S as
acceptance gives S a strictly higher average payout, so rejection and arbitration
could never be an equilibrium response to P’s deviation. Rejection and punishment
beginning the next odd period is also preferred by P. Consequently, P will always
find it desirable to deviate, so that no subgame beginning in an odd period,
including the game itself, can involve an average payout to P of less than
(1 2 d 2 )p m 1 d 2 p dp . But this means that there is no equilibrium that supports
average payouts not included in the set described by the proposition. h

Proof of Result 5. For convenience, label the relevant even period as t52.
Consider that S makes an offer to P at t52 and P rejects. S can either call for
arbitration or not. S will only refrain from calling for arbitration if the average
payout from continuing bargaining is at least dp ds . However, we will show that
this is not possible, so that S will always call for arbitration at t52.
To see this, consider that strategies giving S at least p ds in average profits from
t53 on exist. Consider that P deviates from these strategies and offers (p m 2
p ds 1 ´, p sd 2 ´) at t53. If there always exists an ´ .0 such that S will accept this
offer at t53 then the strategies cannot form an equilibrium.
Clearly for ´ small enough, S will never reject the offer and call for arbitration,
as the average payout from arbitration is dp ds . If S rejects the offer and continues,
then the maximum expected average payout to S from t54 on is given by
d (p m 2 p pd ) when P receives their minimum possible payout. This is equivalent to
]]]]
an average payout at t53 of d 2 (p m 2 p pd ). But, for d ,œp sd /(p m 2 p pd ) this
average payout is strictly less than p ds , so there always exists a ´ .0 such that S
prefers to accept P’s offer rather than continue. This means that the strategies that
give S at least p ds in average profits from t53 on cannot form an equilibrium and
thus the average equilibrium payout from t53 onwards for S must be less than p sd .
Given this, S always prefers to call for arbitration at t52 rather than continue.
Knowing this, P will always accept an offer of at least (1 2 d )pm 1 p pd , so that the
unique equilibrium outcome at t52 is for S to offer ((1 2 d )pm 1 dp dp , d (pm 2
p dp )) and for P to accept. h

Proof of Proposition 6. From Result 5 we know that S can guarantee themselves

d (pm 2 p dp ) by waiting until the second period. Hence for d . p ds /(p m 2 p pd ) S
will never choose arbitration in the first period. The unique subgame perfect
]]]]
payouts for d [ (p ds /(p m 2 p pd ), œp sd /(p m 2 p pd )) follow immediately. For d #
p ds /(p m 2 p pd ), S will always prefer to seek arbitration in the first period than to
wait until the second period. Again the unique subgame perfect payouts of
(p m 2 dp ds , dp ds ) follow immediately. h
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 19

Proof of Result 7. Consider that a firm calls for arbitration in period t and period
T 1t is reached. Assume that if a player is indifferent between accepting and
rejecting an offer in this period then they accept.21 If T 1t is even then the unique
equilibrium in this subgame involves S offering (p dp , p m 2 p pd ) and P accepting. If
T 1t is odd, then the unique equilibrium in this subgame involves P offering
(p m 2 p sd , p sd ) and S accepting.
Now consider that t$2 and period T 1t21 is reached. It immediately follows
that either no agreement is reached in this period or, if T 1t21 is odd, P will offer
(p m (1 2 d ) 1 dp dp , d (p m 2 p dp )) and S will accept or, if T 1t21 is even, S will
offer (p m (1 2 d ) 1 d (p m 2 p ds ), dp ds )) and P will accept.
By backward iteration, it follows that, in any period t, each player can guarantee
themselves an average payoff of (p m (1 2 d T ) 1 d T p pd , d T (p m 2 p pd )) if T 1t is
even and (p m (1 2 d T ) 1 d T (p m 2 p ds ), d T p ds ) if T 1t is odd.
Now, if T is odd, and no agreement or application for intervention has occurred,
it always pays S to call for intervention in the first odd period (so that T 1t is
even). Such intervention will lead to the worst possible payout to P and maximize
the payout to S. Hence, if T is odd, S will always call for intervention in period
one if S rejects P’s offer in that period and the unique subgame perfect average
payoffs when T is odd are given by (p m (1 2 d T ) 1 d T p pd , d T (p m 2 p pd )).
If T is even and no agreement or application for intervention has occurred and
an odd period is reached (so that T 1t is odd), then either P can call for
intervention or not. If P calls for intervention then the unique average payoffs are
given by (p m (1 2 d T ) 1 d T (p m 2 p ds ), d T p sd ). If neither P nor S call for
intervention, then the unique subgame perfect payoffs are given by (p m (1 2
d T 11 ) 1 d T 11 p dp , d T 11 (p m 2 p pd )). This follows as if agreement is not reached in
the next even period, S will call for intervention. It is easy to confirm that P
prefers to call for intervention if d $ p ds /(p m 2 p dp ), but not otherwise. It is also
easy to confirm that S will not call for intervention in an odd period when T is
even if d $ p ds /(p m 2 p dp ) but will otherwise. Thus, if T is even and an odd
period is reached without agreement or earlier application for intervention then
either P or S will always call for intervention. Hence, if T is odd, either S and / or
P will always call for intervention in period one if S rejects P’s offer in that period
and the unique subgame perfect average payoffs when T is even are given by
(p m (1 2 d T ) 1 d T (p m 2 p ds ), d t p ds ). h

Proof of Result 8. First, assume that there exists an equilibrium commencing in

odd periods that gives P an average payoff of p m 2 dp ds and gives S an average
payoff of dp ds . Denote the equilibrium strategies by s˜ sp and s˜ ss for P and S
respectively. Then the following strategies form a subgame perfect equilibrium

21
This avoids trivial non-existence due to the set of real numbers strictly greater than zero being an
open set.
20 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22

commencing in an even period with average payoffs ((1 2 d )p m 1 dp pd , d (p m 2

p dp )).

s̃ pp In first (even) period accept any offer of at least (1 2 d )p m 1 dp dp .

Otherwise reject and seek arbitration. If reach an odd period, play s˜ ps
s̃ sp In first (even) period offer ((1 2 d )p m 1 dp pd , d (p m 2 p pd )). If rejected
call for arbitration. If reach an odd period play s˜ ss .

Clearly no player will deviate if they reach an odd period as they are playing
equilibrium strategies. Similarly, no player will deviate if negotiations fail in the
first (even) period as they believe that the other player will seek arbitration. Given
this, it pays P to accept any offer that is at least (1 2 d )p m 1 dp pd , and it pays S to
make exactly this offer.
To show that there exists an equilibrium commencing in odd periods that gives
P an average payoff of p m 2 dp sd and gives S an average payoff of dp sd , consider
the following strategies:

s̃ sp In first (odd) period offer (p m 2 dp sd , dp ds ). If rejected seek arbitration. If

p
reach an even period play s˜ p .
s ss In first (odd) period accept any offer of at least dp sd . Otherwise reject and
p
call for arbitration. If reach an even period play s˜ s .

By the same argument as above, no player will deviate and the strategies form
an equilibrium.
Now, for any (x, y) that satisfies the restrictions given in Result 8, consider the
following strategies.

sp At t51 offer (x, y). If offer of (x, y) rejected, seek arbitration. Otherwise
do not seek arbitration. If reach t52 always play s˜ pp .
s̃s At t51 accept offer (x, y). If reject (x, y), seek arbitration. Reject any other
offer and do not seek arbitration. If reach t52 play s˜ ps .

It is obvious that these strategies form an equilibrium if t52 is reached.

At t51, both S and P prefer not to call for arbitration if they believe that the
other player is not going to call for arbitration. However, both prefer to call for
arbitration if they believe that the other player will call for arbitration. To see this
note that S receives d 2 (p m 2 p pd ) by not unilaterally calling for arbitration at t51
and receives d (p sd 1 ´) by calling for intervention, so if d . (p sd 1 ´) /(p m 2 p pd )
then S prefers not to seek intervention alone. Similarly, P receives (1 2 d 2 )p m 1
d 2 p dp by not seeking intervention and (1 2 d )p m 1 d (p dp 1 ´) by unilaterally
seeking intervention so if ´ , (p m 2 p pd )(1 2 d ), P will prefer not to seek
intervention alone. However, because the regulator rewards the firm seeking
 S.P. King, R. Maddock / Information Economics and Policy 11 (1999) 1 – 22 21

intervention and only one firm needs to ask for intervention for the regulator to
step in, each firm always prefers to call for intervention if they believe that the
other firm is going to call for intervention.
For the strategies above, if P deviates and sets any offer other than (x, y) then
both firms believe that there will not be arbitration. The payoff to P from such a
deviation is given by (1 2 d 2 )p m 1 d 2 p dp which cannot exceed x. Thus P will
never deviate at t51. If S deviates and rejects (x, y) then S expects intervention to
occur with a payoff of p ds which never exceeds y. Thus S will not deviate.
As no player will deviate in any period, sp and ss form an equilibrium.
The proof that there are no equilibria that support other payouts is identical to
the proof of Proposition 4. h

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