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Price Regulation and the Cost of Capital

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This paper investigates how price regulation under moral hazard can affect a regulated firm’s cost of capital. We consider stylised versions of the two most typical regulatory frameworks that have been applied over the last 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 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 the Cost of Service regulation.

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  • Fernando T. Camacho & Flavio M. Menezes, 2010. "Price Regulation and the Cost of Capital," Discussion Papers Series 413, School of Economics, University of Queensland, Australia.
  • Handle: RePEc:qld:uq2004:413
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    File URL: http://www.uq.edu.au/economics/abstract/413.pdf
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    1. Gianni De Fraja & Clive Stones, 2004. "Risk and Capital Structure in the Regulated Firm," Journal of Regulatory Economics, Springer, vol. 26(1), pages 69-84, July.
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