The evolution of regulatory relationships; regulatory institutions and firm behaviour in privatized industries

The radical changes instituted in the regulation of privatized public utilities in the UK in the 1980s and early 1990s have been the subject of extensive discussion, and have been partly instrumental in the development of ‘regulatory economics’ more widely. In this paper we argue that the conventional economics of regulation, based on principal‐agent and related perspectives, treat the issue too narrowly and statically. Drawing on organizational sociology and cooperative game theory, we contend that it is essential to understand the process by which the interaction between the regulator and the regulated firms evolves. Using interview and documentary data, the paper describes the evolution of this relationship in three sectors in the UK. The growth of cooperative informal relationships between regulators and regulatory functions within firms involves the emergence and development of ‘regulatory expertise’. This generates advantages for both sides, which are examined in terms of different regulatory games involving different levels of trust. The implications both for institutional design and for the economic theory of regulation are assessed.