We analyze a regulation model in which a government delegates constructingfacilities such as toll expressways to one or two firms in two different regions. The firms are assumed to have private information about its cost which depends on regional productivity and cost reduction effort. The probability distribution of the regional productivity parameters can be independent or correlated. The timing of the contracting game is as follows. At the first period, the government determines an industry structure: contracting with one firm or two firms. The government also decides on residual claimancy and a monitoring instrument. At the second period, the productivity parameters are known only to the firms. At the third period, the government offers a contract to the firms. At the fourth period, the firms construct facilities and exert cost reduction effort. At the final period, monetary transfers take place.

Under the decentralized structure, the government contracts with two separate firms. We show that the government prefers to be a residual claimant and to choose input monitoring and obtains the highest payoff. When the government grants residual claimancy to the firm and implement input monitoring, the government gets the lowest payoff. The government obtains the intermediate payoff under output monitoring irrespective of the choice of residual claimancy. Under the integrated industry in which the government contracts with a single firm operating in the two regions, we show that the government chooses to be a residual claimant and to implement input monitoring and obtains the highest payoff. The crucial difference between the decentralized and the integrated industry is that the government may choose output monitoring and obtain the highest payoff when the probability distribution of the regional productivity parameters is correlated. Moreover, when implementing output monitoring, the government always chooses the integrated industry and obtains higher payoff than under the decentralized industry. The reason is that under the integrated industry, there exist informational economies of scope and it reduces information rent.