Traditionally, labour unions have been strong in many regulated industries. Wages and working conditions are determined by bargaining between unions and em-

In many regulated industries labour unions are strong and there is clear empirical evidence of labour rent-sharing. In this paper, we study optimal regulation in a model in which wages are determined endogenously by wage bargaining at the firm level. A seemingly robust conclusion, at least when worker bargaining power is considerable, is that incentives for cost efficiency should be stronger than in the standard case in which wages do not depend on the regulatory regime.