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Irreversible Investments and Regulatory Risk

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  • Paolo M. Panteghini
  • Carlo Scarpa

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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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 934.

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

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

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References

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  1. Andrew B. Abel & Avinash K. Dixit & Janice C. Eberly & Robert S. Pindyck, 1995. "Options, the Value of Capital, and Investment," NBER Working Papers 5227, National Bureau of Economic Research, Inc.
  2. Sappington, David E. M. & Weisman, Dennis L., 1996. "Revenue sharing in incentive regulation plans," Information Economics and Policy, Elsevier, Elsevier, vol. 8(3), pages 229-248, September.
  3. 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, December.
  4. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1995. "Tax Reforms and Investment: A Cross-Country Comparison," NBER Working Papers 5232, National Bureau of Economic Research, Inc.
  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, Springer, vol. 9(3), pages 211-25, May.
  6. Ai, Chunrong & Sappington, David E M, 2002. "The Impact of State Incentive Regulation on the U.S. Telecommunications Industry," Journal of Regulatory Economics, Springer, Springer, vol. 22(2), pages 133-59, September.
  7. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers 368, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Lyon, T.P., 1993. "A Model of Sliding-Scale Regulation," Papers, Indiana - Center for Econometric Model Research 93-011, Indiana - Center for Econometric Model Research.
  9. 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.
  10. Abel, Andrew B & Eberly, Janice C, 1996. "Optimal Investment with Costly Reversibility," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 63(4), pages 581-93, October.
  11. Dixit, Avinash, 1991. "Irreversible Investment with Price Ceilings," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(3), pages 541-57, June.
  12. Carlo Scarpa & Paolo Panteghini, 2001. "Incentives to (Irreversible) Investments Under Different Regulatory Regimes," CESifo Working Paper Series 417, CESifo Group Munich.
  13. Panteghini, Paolo & Scarpa, Carlo, 2003. "The Distributional Efficiency of Alternative Regulatory Regimes: A Real Option Approach," International Tax and Public Finance, Springer, Springer, vol. 10(4), pages 403-18, August.
  14. 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.
  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.
  16. Sandmo, Agnar, 1979. "A note on the neutrality of the cash flow corporation tax," Economics Letters, Elsevier, Elsevier, vol. 4(2), pages 173-176.
  17. 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.
  18. Weisman, Dennis L, 1993. "Superior Regulatory Regimes in Theory and Practice," Journal of Regulatory Economics, Springer, Springer, vol. 5(4), pages 355-66, December.
  19. Sumru Altug & Michel Demers, 2001. "The Impact of Tax Risk and Persistence on Investment Decisions," Economics Bulletin, AccessEcon, vol. 5(1), pages 1-5.
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Citations

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Cited by:
  1. Dino Falaschetti, 2004. "Can Voting Reduce Welfare? Evidence from the US Telecommunications Sector," Public Economics, EconWPA 0401009, EconWPA.
  2. Ingo Vogelsang, 2010. "Incentive Regulation, Investments and Technological Change," CESifo Working Paper Series 2964, CESifo Group Munich.
  3. Gries, Thomas & Prior, Ulrich & Sureth, Caren, 2007. "Taxation of risky investment and paradoxical investor behavior," arqus Discussion Papers in Quantitative Tax Research 26, arqus - Arbeitskreis Quantitative Steuerlehre.
  4. Pawlina, Grzegorz & Kort, Peter M., 2005. "Investment under uncertainty and policy change," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 29(7), pages 1193-1209, July.
  5. Michele Moretto & Paolo M. Panteghini & Carlo Scarpa, 2006. "Profit Sharing and Investment by Regulated Utilities: A Welfare Analysis," Working Papers, University of Brescia, Department of Economics ubs0611, University of Brescia, Department of Economics.
  6. Michele Moretto & Paolo Panteghini & Carlo Scarpa, 2003. "Investment Size and Firm's Value under Profit Sharing Regulation," CESifo Working Paper Series 1040, CESifo Group Munich.
  7. Schneider, Georg & Sureth, Caren, 2010. "The impact of profit taxation on capitalized investment with options to delay and divest," arqus Discussion Papers in Quantitative Tax Research 97, arqus - Arbeitskreis Quantitative Steuerlehre.
  8. Roland Strausz, 2009. "Regulatory Risk under Optimal Incentive Regulation," SFB 649 Discussion Papers SFB649DP2009-006, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  9. Dino Falaschetti, 2003. "Voter Turnout, Regulatory Commitment, and Capital Accumulation: Evidence from the US Telecommunications Sector," Microeconomics, EconWPA 0311002, EconWPA.
  10. Dino Falaschetti, 2004. "Can Voting Reduce Welfare? Evidence from the US Telecommunications Sector," Public Economics, EconWPA 0401006, EconWPA.

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