Risk Sharing, the Cost of Equity and the Optimal Capital Structure of the Regulated Firm

Risk Sharing, the Cost of Equity and the Optimal Capital Structure of the Regulated Firm 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Industrial Organization Springer Journals

Risk Sharing, the Cost of Equity and the Optimal Capital Structure of the Regulated Firm

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Publisher
Kluwer Academic Publishers-Plenum Publishers
Copyright
Copyright © 2007 by Springer Science+Business Media, LLC
Subject
Economics; Industrial Organization; Microeconomics
ISSN
0889-938X
eISSN
1573-7160
D.O.I.
10.1007/s11151-007-9131-2
Publisher site
See Article on Publisher Site

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.

Journal

Review of Industrial OrganizationSpringer Journals

Published: May 22, 2007

References

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