Idiosyncratic risk and the cost of capital - The case of electricity networks

Schober, Dominik ; Schaeffler, Stephan ; Weber, Christoph

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URN: urn:nbn:de:bsz:180-madoc-358763
Document Type: Working paper
Year of publication: 2014
The title of a journal, publication series: ZEW Discussion Papers
Volume: 14-010
Place of publication: Mannheim
Publication language: English
Institution: Sonstige Einrichtungen > ZEW - Leibniz-Zentrum für Europäische Wirtschaftsforschung
MADOC publication series: Veröffentlichungen des ZEW (Leibniz-Zentrum für Europäische Wirtschaftsforschung) > ZEW Discussion Papers
Subject: 330 Economics
Classification: JEL: G32 , G33 , L51 , L94,
Keywords (English): Idiosyncratic/firm-specific risk , discrimination , incentive-based and quality regulation , liquidity management , size effects , electricity networks
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 (WACC), 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 approximately 0.2 to 3.0 percentage points depending on the size of the firm (in the range of 3% to 40% of total cost of capital). Regulation of monopolistic bottlenecks should take these risks into account to avoid implicit discrimination.

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