Risk Sharing,the Cost of Equity and the Optimal Capital Structure of the Regulated Firm |
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Authors: | Clive J Stones |
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Institution: | (1) Department of Economics and Related Studies, The University of York, Heslington, York, YO10 SDD, UK;(2) Rookwood, Bromley Road, Bingley, West Yorkshire, BD16 4DA, UK |
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Abstract: | This paper considers the relationship between the regulator’s pricing decision and the allocation of risk between consumers
and shareholders. Consumers are willing to trade-off price variations against a lower expected price. Prices are higher in
adverse economic conditions, but shareholder returns are not necessarily lower. It might be optimal to insure shareholders
against market risk, so that consumers could thereby achieve a lower expected price. The allocation of risk between consumers
and shareholders depends on the capital structure of the regulated firm, and a very special set of conditions must apply for
the social optimum to be 100% debt finance with the firm operating on a ‘not-for-profit’ basis.
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Keywords: | Capital structure Cost of equity Debt finance Leverage Regulation Risk |
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