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Dilution Costs, Underinvestment, and Utility Regulation under Asymmetric Information

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  • Kale, Jayant R
  • Noe, Thomas H

Abstract

This article addresses the problem faced by a regulated natural monopolist who must raise outside funds to finance socially desirable projects. We demonstrate that "fair rate of return" utility price regulation will lead to underinvestment incentives in the presence of asymmetric information between the firm and the capital markets regarding the firm's assets and future costs. This problem is especially severe when financing choice is restricted to equity. Underinvestment can be either completely eliminated by adjusting the allowed rate of return above the fair rate or reduced by switching to debt finance. Copyright 1995 by Kluwer Academic Publishers

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  • Kale, Jayant R & Noe, Thomas H, 1995. "Dilution Costs, Underinvestment, and Utility Regulation under Asymmetric Information," Journal of Regulatory Economics, Springer, vol. 7(2), pages 177-197, March.
    • Handle: RePEc:kap:regeco:v:7:y:1995:i:2:p:177-97
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    Cited by:

    1. Sanyal, Paroma & Bulan, Laarni T., 2011. "Regulatory risk, market uncertainties, and firm financing choices: Evidence from U.S. Electricity Market Restructuring," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(3), pages 248-268, June.

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