The paper analyzes the performance of merchant investments in electricity transmission capacity expansions. Given a market design based on nodal pricing and bid-based dispatch,
we model sequential merchant transmission investments by an incumbent and a new entrant, in a two-node setting characterized by perfectly competitive wholesale energy markets. We examine the effects of alternative regulatory arrangements on the incumbent's strategies in the
face of an entry threat as well as on social welfare. Namely, we evaluate a mechanism based on a must-offer rule, in which the installed transmission capacity cannot be withdrawn, compared to a standard system in which the investor can choose the amount of transmission capacity to make available. We show that, despite the ex-post pro-competitive effect of a must-offer rule in preventing inefficient capacity withholding, such a rule may ex-ante reduce entry possibilities and make the incumbent more aggressive post-entry. This in turn results in the must-offer rule being welfare reducing when fixed costs are sufficiently large