Recent economic literature has given a great deal of attention to the behavior of the firm under a regulatory constraint. Such efforts include theoretical extensions of the classic article by Averich and Johnson (1962) by Kennedy (1977), as well as empirical tests of the overcapitalization hypothesis by Leland (1974), Smithson (1978) and Spann (1974). In addition, there have been notable attempts to provide a general theory of regulation by Stigler (1971) and Peltzman (1976). Against this background, surprisingly little attention has been paid to the effect of regulation on the compensation of chief executive officers. The effect of regulation on executive rewards strikes at the heart of why regulated firms appear to behave differently than their less regulated counterparts. The only explicit attempts to relate executive compensation to the presence of regulation appear to be the work of Smyth, Boyes and Peseau (1975) and Ciscel (1977). The apparent oversight of this issue is perhaps best explained by the persistence of the controversy over the nature of the objective function of corporate decision makers introduced as the maximization' hypothesis by Baumol (1967). For the last two decades, the debate over whether corporate decision makers maximize sales or maximize profits has been couched in either-or terms. Proponents of each side of the debate, like Smyth, Boyes and Peseau (1975) and Ciscel (1974) on the managerialist side, and Lewellen and Huntsman (1970) and Masson (1971) on the neoclassical side, have produced evidence for their respective positions. Ciscel and Carroll ( 1980) provide an econometric resolution of the conflict, pointing out the compatibility of the data with both hypotheses, given a proper specification of the compensation-performance equations. Consideration of the impact of regulation on executive rewards has significance for understanding the different rewards in the regulated sectors and it illuminates the implicit incentives for executive behavior in regulated and unregulated firms. Maximum profits or optimal sales can never be directly observed. All that can be measured is whether or not the pattern of executive compensation is consistent with such maximization objectives. This aspect of economic analysis is particularly important when gauging the effect of regulation on executive pay. The impact of the absence of regulation on compensation can be contrasted to two alternatives: regulation establishes maximum prices as is the case in utilities, while regulation prescribed minimum prices as was the case in the transportation sector (see Jordan, 1972). Executive compensation reflects not only incentive changes brought about by the existence of regulation, but also the form regulation takes

We consider the problem of how to regulate a monopolistic firm whose costs are unknown to the regulator. The regulator's objective is to maximize a linear social welfare of the consumers' surplus and the firm's profit. In the optimal regulatory policy, prices and subsidies are designed as functions of the firm's cost report so that expected social welfare is maximized, subject to the constraints that the firm has nonnegative profit and has no incentive to misrepresent its costs. We explicitly derive the optimal policy and analyze its properties. IN THEIR CLASSIC PAPERS Dupuit [2] and Hotelling [5] considered pricing policies for a bridge that had a fixed cost of construction and zero marginal cost. They demonstrated that the pricing policy that maximizes consumer well-being is to set price equal to marginal cost and to provide a subsidy to the supplier equal to the fixed cost, so that a firm would be willing to provide the bridge. This first-best solution is based on a number of informational assumptions. First, the demand is assumed to be known to both the regulator and to the firm. While the assumption of complete information may be too strong, the assumption that information about demand is as available to the regulator as it is to the firm does not seem unnatural. A second informational assumption is that the regulator has complete information about the cost of the firm or at least has the same information about cost as does the firm. This assumption is unlikely to be met in reality, since the firm would be expected to have better information about costs than would the regulator. As Weitzman has stated, An essential feature of the regulatory environment I am trying to describe is uncertainty about the exact specification of each firm's cost function. In most cases even the managers and engineers most closely associated with production will be unable to precisely specify beforehand the cheapest way to generate various hypothetical output levels. Because they are yet removed from the production process, the regulators are likely to be vaguer still about a firm's cost function [12, p. 684]. As this observation suggests, it is natural to expect that a firm would have better information regarding its costs than would a regulator. The purpose of this paper is to develop an optimal regulatory policy for the case in which the regulator does not know the costs of the firm. One strategy that a regulator could use in the absence of full information about costs is to give the firm the title to the total social surplus and to delegate the pricing decision to the firm. In pursuing its own interests, which would then be to maximize the total social surplus, the firm would adopt the same marginal cost pricing strategy that the regulator would have imposed if the regulator had

In choosing a two-part tariff, a monopoly subject to rate-of-return regulation will rely more on demand elasticities and less on marginal costs than would a welfare-maximizing firm. The rate-of-return regulated firm also will reduce its access fee or its marginal usage fee more, depending on whether adding consumers or increasing output requires marginally the most capital. In the typical case these effects will favor declining-block rate structures, which helps to explain their widespread use by rate-of-return regulated firms

MILTON FRIEDMAN AND ANNA SCHWARTZ Monetary Trends reports a great many findings-53 are enumerated in the introduction-but paramount is the stability of the demand for money in the US and Britain over the past century. The money stock controls money income. This proposition more than anything else is the point of their painstaking investigation. Friedman and Schwartz argue against what might neutrally be called the early post-war view of the macroeconomic role of money: Velocity will move easily to reconcile any level of nominal income to any money stock. The demand for money in this view is a will-o'the-wisp, as the authors put it. Monetary policy has little influence over real activity; stabilization policy necessarily relies on fiscal instruments. The volume is completely convincing in disposing of this idea; today's reader is likely to be puzzled why so much space is devoted to a view that has no serious adherents among professional economists. Friedman and Schwartz are generals fighting an earlier war, a situation accentuated by the long lags in putting this volume into print. Though the opposing armies fighting for the early postwar view have withdrawn in total rout, a new front has opened up, and the quantity theory is fighting for its life once again. Worse yet, the new armies are fighting under the banner of free-market economics and are led by former colleagues and students of Milton Friedman. The midwest, once the stronghold of the quantity theory, is now largely occupied by the enemy. The new monetary economics views the quantity theory as nothing more than an artifact of government regulation. An economy organized along free-market principles could function without money at all (Fischer Black, 1970). It is true that the kinds of monetary regulations imposed by the American and British governments of the past century create a more-or-less stable relation between a certain class of assets called money and nominal spending (Eugene Fama, 1980), but different regulations would alter that relation. Even the real bills doctrine, anathema to quantity theorists because it invites unlimited expansion of the money supply, has advocates in the new school (Thomas Sargent and Neil Wallace, 1981). monetary system where the government is unconcerned about the money stock has been advocated by a University of Chicago economist while visiting the Hoover Institution (John Bilson, 1981). Restoring the intrinsic value of money, not limiting its quantity, has been found to be the key to successful disinflation by one member of this group (Sargent, 1982). critical summary, titled A Laissez Faire Approach to Monetary Stability, written * See p. 1528, above, for publication information

Reviews the book "Self-Regulation in the Professions: Accounting, Law, Medicine," by Hedvah L. Shuchman

M y assignment is to speak about the regulation of financial futures markets, but in this respect the differences between financial futures and the traditional commodity futures are comparatively minor. Most of what I have to say, therefore, will apply to the regulation of futures markets in general. Towards the end of my remarks I shall say something about the problems that are particular to financial futures

In the May 1980 issue of this REVIEW, Masson and DeBrock (M-D) examine state regulation of fluid-milk retail prices. Although there have been numerous studies on this same topic, their econometric model is by far the most sophisticated, being the first to use a simultaneous system of equations to reveal the structural implications of this form of regulation. M-D test two hypotheses: (a) that regulation raises price, attracting entry and reducing plant scale, and (b) that deregulation temporarily plunges price below its longrun unregulated level.' My first objective here is to show that, when correctly interpreted, M-D's theoretical model implies that the short-run deregulated price may lie above or below the long-run unregulated price, not necessarily below it as the authors infer. My second objective is to retest their hypotheses after making a number of corrections and improvements in their data. As we shall see, my results are supportive of the authors' claims that regulation raises price and decreases plant scale. However, I do not find that market entry can be attributed to regulation unless a decision is made to exclude North Dakota, where two-thirds of the firms actually exitedl during the regulated period. As shown below, this decision hangs on whether 21 months was or was not sufficient time in which to build a processing plant. Like North Dakota, New Jersey also plays a pivotal role. Evidence presented below indicates that M-D misclassified New Jersey (a regulated state) when labeling it deregulated. This mistake alone can explain their finding that deregulation causes price to temporarily drop below the long-run unregulated price level

S. C. Myers, Regulation and Corporate Investment Policy: Discussion, The Journal of Finance, Vol. 37, No. 2, Papers and Proceedings of the Fortieth Annual Meeting of the American Finance Association, Washington, D.C., December 28-30, 1981 (May, 1982), pp. 320-321

Reviews the book "The Economic Role of the Audit in Free and Regulated Markets," by Wanda A. Wallace

Robert Tempest Masson, Lawrence Marvin DeBrock, The Structural Effects of State Regulation of Retail Fluid Milk Prices: A Reply, The Review of Economics and Statistics, Vol. 64, No. 3 (Aug., 1982), pp. 534-536