Irreversible Investments and Regulatory Risk

35 Pages Posted: 8 May 2003

See all articles by Paolo M. Panteghini

Paolo M. Panteghini

Department of Economics and Management; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Carlo Scarpa

University of Brescia; NERA Economic Consulting

Date Written: April 2003

Abstract

This paper addresses the issue of how regulatory constraints affect a firm's investment choices when the firm has an option to delay investment. The RPI-x rule is compared to a profit-sharing rule, which increases the x factor in case profits go beyond a given level. It is shown that a pure price cap and profit sharing are identical in their impact on investment choices: the change in the option value observed with a profit sharing regime exactly compensates the change in the "direct" profitability of investment. Regulatory risk - breaching of the regulatory contract - may or may not affect investment decisions negatively. Even if a distortion exists, we show that this distortion is the same, even if a pure price cap could be considered riskier than a profit-sharing rule.

Keywords: Regulation, Investment, RPI-x, Profit Sharing

JEL Classification: L51, D92, G31

Suggested Citation

Panteghini, Paolo M. and Scarpa, Carlo, Irreversible Investments and Regulatory Risk (April 2003). CESifo Working Paper Series No. 934. Available at SSRN: https://ssrn.com/abstract=404581

Paolo M. Panteghini (Contact Author)

Department of Economics and Management ( email )

Contrada Santa Chiara 50
BRESCIA, BS 25122
Italy

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.cesifo.de

Carlo Scarpa

University of Brescia ( email )

Via San Faustino 74B
Dipartimento di Scienze Economiche
25122 Brescia
Italy
+39+030+2988+833 (Phone)
+39+030+2988+839/840 (Fax)

NERA Economic Consulting ( email )

50 Main Street, 14th Floor
White Plains, NY 10606
United States

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