Idiosyncratic risk and the cost of capital: the case of electricity networks |
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Authors: | Dominik Schober Stephan Schaeffler Christoph Weber |
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Institution: | 1. ZEW Centre for European Economic Research and MaCCI, L7, 1, 68161?, Mannheim, Germany 3. Chair of Management Science and Energy Economics, University of Duisburg Essen, Universit?tsstr. 12, 45117?, Essen, Germany 2. Horvàth & Partners Management Consultants, Ganghoferstr. 39, 80339?, Munich, Germany
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Abstract: | We analyze the treatment and impact of idiosyncratic or firm-specific risk in regulation. Regulatory authorities regularly ignore firm-specific characteristics, such as size or asset ages, implying different risk exposure in incentive regulation. In contrast, it is common to apply only a single benchmark, the weighted average cost of capital, uniformly to all firms. This will lead to implicit discrimination. We combine models of firm-specific risk, liquidity management and regulatory rate setting to investigate impacts on capital costs. We focus on the example of the impact of component failures for electricity network operators. In a simulation model for Germany, we find that capital costs increase by \(\sim \) 0.2 to 3.0 % points depending on the size of the firm (in the range of 3–40 % of total cost of capital). Regulation of monopolistic bottlenecks should take these risks into account to avoid implicit discrimination. |
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