Abstract
This paper proposes a regulatory mechanism for vertically related industries in which the upstream "bottleneck" segment faces significant returns to scale while other (downstream) segments may be more competitive. In the proposed mechanism, the ownership of the upstream firm is allocated to downstream firms in proportion to their shares of input purchases. This mechanism, while preserving downstream competition, partially internalizes the benefits of exploiting economies of scale resulting from an increase in downstream output. We show that this mechanism is more efficient than a disintegrated market structure in which the upstream natural monopoly bottleneck sets a price equal to average cost.