The Contamination Problem in Utility RegulationFernando Tavares Camacho () and
Flavio M. Menenzes
No 352, Discussion Papers Series from University of Queensland, School of Economics Abstract: This paper formally examines the implications of a utility’s diversification into an unregulated industry. In our framework, the utility is the most efficient provider in the unregulated industry (up to a particular capacity) and, as such, there is no question about the desirability of allowing it to operate in that market. Nevertheless, the risk faced by a diversified utility is greater than the risk faced by a utility that operates only in a regulated market. This additional risk can potentially affect the diversified utility’s credit rating and, therefore, increase the cost of capital for the regulated business that will be recovered from ratepayers. We show that by allowing a regulated firm to diversify into an unregulated market, the regulator faces a trade-off: a lower cost in the unregulated market versus a higher cost in the regulated market. If the regulator only cares about welfare in the regulated market, then a ringfencing requirement is optimal subject to implementation costs not being substantial. Of course, the ring-fencing requirement effectively prevents the firm from achieving a lower cost in the unregulated market. Therefore, if the regulator cares about welfare in both regulated and unregulated markets, ring-fencing may no longer be optimal. New Economics Papers: this item is included in nep-mic and nep-reg Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: http://EconPapers.repec.org/RePEc:qld:uq2004:352 Access Statistics for this paper More papers in Discussion Papers Series from University of Queensland, School of Economics |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
Swedish Business School at Örebro University.