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Investment Size and Firm's Value under Profit Sharing Regulation

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  • Michele Moretto
  • Paolo Panteghini
  • Carlo Scarpa

Abstract

In this article we analyse the effects of different regulatory schemes (price cap and profit sharing) on a firm’s investment of endogenous size. Using a real option approach in continuous time, we show that profit sharing does not affect a firm’s start-up decision relative to a pure price cap scheme. Unless the threshold after which profit sharing intervenes is very high, however, introducing a profit sharing element delays further investments: this decreases the present value of total investment. We also evaluate the reduction in the firm’s value due to profit sharing, linking this reduction to the option value of future investments.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2003/wp-cesifo-2003-09/cesifo1_wp1040.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1040.

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Date of creation: 2003
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Handle: RePEc:ces:ceswps:_1040

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Keywords: regulation; investment; profit sharing; real options; RPI-x;

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References

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  1. Dixit, Avinash, 1995. "Irreversible investment with uncertainty and scale economies," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 327-350.
  2. Lyon, Thomas P, 1996. "A Model of Sliding-Scale Regulation," Journal of Regulatory Economics, Springer, vol. 9(3), pages 227-47, May.
  3. Weisman, Dennis L, 1993. "Superior Regulatory Regimes in Theory and Practice," Journal of Regulatory Economics, Springer, vol. 5(4), pages 355-66, December.
  4. Panteghini, Paolo & Scarpa, Carlo, 2003. "The Distributional Efficiency of Alternative Regulatory Regimes: A Real Option Approach," International Tax and Public Finance, Springer, vol. 10(4), pages 403-18, August.
  5. Crew, Michael A & Kleindorfer, Paul R, 1996. "Incentive Regulation in the United Kingdom and the United States: Some Lessons," Journal of Regulatory Economics, Springer, vol. 9(3), pages 211-25, May.
  6. Sappington, David E. M. & Weisman, Dennis L., 1996. "Revenue sharing in incentive regulation plans," Information Economics and Policy, Elsevier, vol. 8(3), pages 229-248, September.
  7. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June.
  8. Burns, Philip & Turvey, Ralph & Weyman-Jones, Thomas G, 1998. "The Behaviour of the Firm under Alternative Regulatory Constraints," Scottish Journal of Political Economy, Scottish Economic Society, vol. 45(2), pages 133-57, May.
  9. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers 368, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Ai, Chunrong & Sappington, David E M, 2002. "The Impact of State Incentive Regulation on the U.S. Telecommunications Industry," Journal of Regulatory Economics, Springer, vol. 22(2), pages 133-59, September.
  11. Mark Armstrong & Simon Cowan & John Vickers, 1994. "Regulatory Reform: Economic Analysis and British Experience," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262510790, January.
  12. M.E. Beesley & S.C. Littlechild, 1989. "The Regulation of Privatized Monopolies in the United Kingdom," RAND Journal of Economics, The RAND Corporation, vol. 20(3), pages 454-472, Autumn.
  13. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, vol. 101(4), pages 707-27, November.
  14. Paolo M. Panteghini & Carlo Scarpa, 2003. "Irreversible Investments and Regulatory Risk," CESifo Working Paper Series 934, CESifo Group Munich.
  15. Colin Mayer & John Vickers, 1996. "Profit-sharing regulation: an economic appraisal," Fiscal Studies, Institute for Fiscal Studies, vol. 17(1), pages 1-18, February.
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Cited by:
  1. Michele Moretto & Paola Valbonesi, 2007. "Firm Regulation and Profit-Sharing: A Real Option Approach," "Marco Fanno" Working Papers 0052, Dipartimento di Scienze Economiche "Marco Fanno".
  2. Michele Moretto & Paola Valbonesi, 2004. "Opting-out in profit-sharing regulation," Industrial Organization 0403001, EconWPA.

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