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

Dominik Schober (), Stephan Schaeffler and Christoph Weber

Journal of Regulatory Economics, 2014, vol. 46, issue 2, 123-151

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, 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 $$\sim $$ ∼ 0.2 to 3.0 % points depending on the size of the firm (in the range of 3–40 % of total cost of capital). Regulation of monopolistic bottlenecks should take these risks into account to avoid implicit discrimination. Copyright Springer Science+Business Media New York 2014

Keywords: Idiosyncratic/firm-specific risk; Discrimination; Incentive-based and quality regulation; Liquidity management; Size effects; Electricity networks; G32; G33; L51; L94 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s11149-013-9242-7

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