Idiosyncratic Risk and the Cost of Capital – The Case of Electricity Networks

26 Pages Posted: 4 Feb 2014

See all articles by Dominik Schober

Dominik Schober

ZEW – Leibniz Centre for European Economic Research

Stephan Schaeffler

Horvàth & Partners Management Consultants

Christoph Weber

University of Duisburg-Essen

Date Written: January 29, 2014

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.

Keywords: Idiosyncratic/firm-specific risk; discrimination; incentive-based and quality regulation; liquidity management; size effects; electricity networks

JEL Classification: G32, G33, L51, L94

Suggested Citation

Schober, Dominik and Schaeffler, Stephan and Weber, Christoph, Idiosyncratic Risk and the Cost of Capital – The Case of Electricity Networks (January 29, 2014). ZEW - Centre for European Economic Research Discussion Paper No. 14-010. Available at SSRN: https://ssrn.com/abstract=2387515 or http://dx.doi.org/10.2139/ssrn.2387515

Dominik Schober (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

Stephan Schaeffler

Horvàth & Partners Management Consultants ( email )

Ganghoferstr. 39
Munich, 80339
Germany

Christoph Weber

University of Duisburg-Essen ( email )

Universitätsstraße 2
Essen, 45141
Germany

HOME PAGE: http://www.ewl.wiwi.uni-due.de

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