Idiosyncratic risk and the cost of capital: The case of electricity networks

Dominik Schober, Stephan Schäffler and Christoph Weber

No 14-010, ZEW Discussion Papers from ZEW - Leibniz Centre for European Economic Research

Abstract: We analyze the treatment and impact of idiosyncratic or firm-specific risk in regulation. Regulatory authorities regularly ignore firm-specific characteristics, such as size or asset ages, implying different risk exposure in incentive regulation. In contrast, it is common to apply only a single benchmark, the weighted average cost of capital (WACC), uniformly to all firms. This will lead to implicit discrimination. We combine models of firm-specific risk, liquidity management and regulatory rate setting to investigate impacts on capital costs. We focus on the example of the impact of component failures for electricity network operators. In a simulation model for Germany, we find that capital costs increase by approximately 0.2 to 3.0 percentage points depending on the size of the firm (in the range of 3% to 40% of total cost of capital). Regulation of monopolistic bottlenecks should take these risks into account to avoid implicit discrimination.

Keywords: Idiosyncratic/firm-specific risk; discrimination; incentive-based and quality regulation; liquidity management; size effects; electricity networks (search for similar items in EconPapers)
JEL-codes: G32 G33 L51 L94 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-ene, nep-reg and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:zewdip:14010

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