Is the Regulatory Control of Utilities’ Capital Structures Always Justified?

Abstract:     
This work analyses whether there are reasons for regulators to control the capital structures of utilities firms. That control is commonly seen as a suitable ex-ante form of prevention of financial distress. The case of UK utilities is used as case study. It is shown that various concerns related to high levels of debt are unfounded, mainly because the specificities of the regulatory regime have not been taken into account. Contrary to what underlies some concerns, the economic benefits of price-cap regulation are not necessarily undermined with the change in the capital structures of the firms. Also, incentive-based regulation is not necessarily incompatible with high levels of debt. Finally, it is shown that there is still a need for regulators to control the capital structure of regulated utilities. The capital structure affects the distribution of risk between firms and consumers and ultimately the prices paid by the latter. Therefore, the need for a more open link between risk and the regulatory outcome is needed. The challenge is to adapt without losing the incentives-based characteristics of the regime.

Number of Pages in PDF File: 36

Keywords: Capital Structure, Utilities, Risk, Regulation, UK

JEL Classification: G32, G38, K23, L59, L97, L99

working papers series