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Irreversible Investments and Regulatory Risk

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Author Info
Panteghini, Paolo M.
Scarpa, Carlo

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Abstract

This paper addresses the issue of how regulatory constraints affect firm's investment choices when the firm has an option to delay investment. The RPI-x rule is compared to a profit sharing rule, which increases the x factor in case profits go beyond a given level. It is shown that a pure price cap and profit sharing are identical in their impact on investment choices: the change in the option value that we have with a profit sharing regime exactly compensates the change in the "direct" profitability of investment. Regulatory risk -- breaching of the regulatory contract -- may or may not affect negatively investment decisions. Even if a distortion exists, we show that this distortion is the same, even if a pure price cap could be considered riskier than a profit sharing rule.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 934.

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Date of creation: 2003
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Handle: RePEc:ces:ceswps:_934

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Related research
Keywords: regulation; investment; RPI-x; profit sharing;

Other versions of this item:

Find related papers by JEL classification:
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 541-57, June. [Downloadable!] (restricted)
  2. 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. [Downloadable!] (restricted)
    Other versions:
  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. 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. [Downloadable!] (restricted)
  5. 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. [Downloadable!] (restricted)
  6. Sandmo, Agnar, 1979. "A note on the neutrality of the cash flow corporation tax," Economics Letters, Elsevier, vol. 4(2), pages 173-176. [Downloadable!] (restricted)
  7. Lyon, Thomas P, 1996. "A Model of Sliding-Scale Regulation," Journal of Regulatory Economics, Springer, vol. 9(3), pages 227-47, May.
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  8. Cummins, Jason G. & Hassett, Kevin A. & Hubbard, R. Glenn, 1996. "Tax reforms and investment: A cross-country comparison," Journal of Public Economics, Elsevier, vol. 62(1-2), pages 237-273, October. [Downloadable!] (restricted)
    Other versions:
  9. Sumru Altug & Fanny S. Demers & Michel Demers, 2001. "The Impact of Tax Risk and Persistence on Investment Decisions," Economics Bulletin, Economics Bulletin, vol. 5, pages 1-5. [Downloadable!]
  10. 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. [Downloadable!] (restricted)
  11. Laffont, Jean-Jacques & Tirole, Jean, 1986. "Using Cost Observation to Regulate Firms," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 614-41, June. [Downloadable!] (restricted)
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  12. 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.
  13. Kevin Hassett & Gilbert E. Metcalf, 1994. "Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," NBER Working Papers 4780, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Andrew B. Abel & Avinash Dixit & Janice C. Eberly & Robert S. Pindyck, 1996. "Options, the Value of Capital, and Investment," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 753-77, August. [Downloadable!] (restricted)
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  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. [Downloadable!]
  16. Panteghini, Paolo & Carlo Scarpa, 2002. "Incentives to (irreversible) investments under different regulatory regimes," Royal Economic Society Annual Conference 2002 154, Royal Economic Society. [Downloadable!]
    Other versions:
  17. Abel, Andrew B & Eberly, Janice C, 1996. "Optimal Investment with Costly Reversibility," Review of Economic Studies, Blackwell Publishing, vol. 63(4), pages 581-93, October. [Downloadable!] (restricted)
    Other versions:
  18. 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. [Downloadable!] (restricted)
  19. 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.
  20. Thomas P. Lyon & John W. Mayo, 2005. "Regulatory Opportunism and Investment Behavior: Evidence from the U.S. Electric Utility Industry," RAND Journal of Economics, The RAND Corporation, vol. 36(3), pages 628-644, Autumn.
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Michele Moretto & Paolo M. Panteghini & Carlo Scarpa, 2007. "Profit Sharing and Investment by Regulated Utilities: a Welfare Analysis," "Marco Fanno" Working Papers 0059, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
    Other versions:
  2. Dino Falaschetti, 2004. "Can Voting Reduce Welfare? Evidence from the US Telecommunications Sector," Public Economics 0401009, EconWPA. [Downloadable!]
  3. Michele Moretto & Paolo Panteghini & Carlo Scarpa, 2003. "Investment Size and Firm's Value under Profit Sharing Regulation," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  4. Dino Falaschetti, 2004. "Can Voting Reduce Welfare? Evidence from the US Telecommunications Sector," Public Economics 0401006, EconWPA. [Downloadable!]
  5. Dino Falaschetti, 2003. "Voter Turnout, Regulatory Commitment, and Capital Accumulation: Evidence from the US Telecommunications Sector," Microeconomics 0311002, EconWPA. [Downloadable!]
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