Implicit Yardstick Competition

We examine a novel regulatory mechanism, in which otherwise unrelated monopolists are in implicit price competition. The mechanism resembles the classical yardstick competition, however the reference standard is set not by the regulator but by the customers. They demand fair prices and infer about the price fairness through a spatial price comparison. We test this mechanism using a unique dataset on unregulated District Heating natural monopolists in Sweden. To account for the endogeneity of reference prices, we use a novel instrument that utilizes a shock on the demand side triggered by an unanticipated policy reform. We find a large effect of reference prices on prices, which indicates that the implicit yardstick competition has a considerable disciplining effect on monopoly prices.