Regulatory Risk and the Cost of Capital: Determinants and by Burkhard Pedell

By Burkhard Pedell

Austrian Controller Award 2005

This publication develops a complete suggestion of regulatory hazard integrating present theoretical and empirical learn. the point of interest is on explaining how the layout of the regulatory process affects the danger of a rate-regulated enterprise, in addition to on elaborating applicable equipment for the selection of the regulatory fee base and the allowed fee of go back. in regards to the regulatory cost base, the query of even if industry worth of capital or publication worth of resources may be hired and the alternative of the depreciation scheme are on the middle of the dialogue. particular methodical matters referring to rate of capital evaluate for rate-regulated corporations are analyzed, i.e. the circularity of expense law, the sharing of hazards among capital vendors and fee payers, the size of the regulatory overview interval, the law of the capital constitution in addition to the conversion of a post-tax to pre-tax weighted general fee of capital.

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Cf. ); Brennan/Schwartz (1982a); Carleton/Chambers/Lakonishok (1983, 420); Houston (1996, 3). Cf. ). 2. Without this irreversibility, even a natural monopoly with strong economies of scale could be disciplined by potential competition. 30 3 Impact of Rate Regulation on the Risk of a Regulated Firm ing the firm an appropriate rate of return on this investment. Firstly, the regulatory contract necessarily remains incomplete due to incomplete information, and secondly, the regulator lacks credible mechanisms for commitment.

93 In the special case of the privatization of electricity distribution in developing countries, it has been proposed to backstop a pre-defined regulatory framework and process by a partial risk guarantee of the World Bank. 94 Reasonable prospects for cost recovery depend on both an 88 89 90 91 92 93 94 Also cf. Appleyard/McLaren (1996) and Grayburn/Hern/Lay (2002, 7). Cf. Grayburn/Hern/Lay (2002, 6). Cf. Shuttleworth/MacKerron (2002, 34). Cf. Shuttleworth/MacKerron (2002, 32). Gilbert/Newberry (1994, 551).

It will always have discretionary power to deviate from an announced course of action and to change the regulatory system. 86 This twofold commitment problem is aggravated by the fact that the typical asset life time in regulated industries is much longer than the regulatory review period. The commitment problem gains importance with increasing regulatory lag, longer review periods and longer asset life, as costs have to be estimated for a longer period and rate setting is less strictly orientated towards actual costs of the regulated utility.

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