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Journal of Regulatory Economics

, Volume 46, Issue 2, pp 123–151 | Cite as

Idiosyncratic risk and the cost of capital: the case of electricity networks

  • Dominik Schober
  • Stephan Schaeffler
  • Christoph Weber
Original Article

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.

Keywords

Idiosyncratic/firm-specific risk Discrimination Incentive-based and quality regulation Liquidity management  Size effects Electricity networks 

JEL Classification

G32 G33 L51 L94 

Notes

Acknowledgments

For useful discussions on earlier versions of the paper, the authors want to thank the participants of the 29th Annual Eastern Conference of the Rutgers Center for Research in Regulated Industries, especially Howard Spinner and Kathleen King, as well as the participants of the 8th Conference on Applied Infrastructure Research at the TU Berlin and the 2nd Annual Competition and Regulation in Network Industries Conference in Brussels. We also would like to thank the participants of an internal workshop at the ZEW in Mannheim, especially Konrad Stahl and Oliver Woll. Remaining errors are solely ours.

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Copyright information

© Springer Science+Business Media New York 2014

Authors and Affiliations

  • Dominik Schober
    • 1
    • 3
  • Stephan Schaeffler
    • 2
  • Christoph Weber
    • 3
  1. 1.ZEW Centre for European Economic Research and MaCCIMannheimGermany
  2. 2.Horvàth & Partners Management ConsultantsMunichGermany
  3. 3.Chair of Management Science and Energy EconomicsUniversity of Duisburg EssenEssenGermany

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