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The Impact of Price Regulation on the Cost of Capital
Author(s) -
Camacho Fernando T.,
Menezes Flavio M.
Publication year - 2013
Publication title -
annals of public and cooperative economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.526
H-Index - 37
eISSN - 1467-8292
pISSN - 1370-4788
DOI - 10.1111/apce.12007
Subject(s) - stylized fact , moral hazard , economics , capital (architecture) , microeconomics , cost of capital , factor price , service (business) , business , industrial organization , incentive , macroeconomics , economy , history , archaeology
ABSTRACT This paper investigates how price regulation under moral hazard can affect a regulated firm's cost of capital. We consider stylized versions of the two most typical regulatory frameworks that have been applied in the most recent decades by regulators: Price Cap and Cost of Service. We show that there is a trade‐off between lower operational costs and a higher cost of capital under Price Cap regulation and higher operational costs and a lower cost of capital under Cost of Service regulation. As a result, when the extent of moral hazard is not significant, Price Cap regulation generates lower welfare than does Cost of Service regulation .