IRREVERSIBLE INVESTMENTS AND REGULATORY RISK PAOLO M. PANTEGHINI CARLO SCARPA
CESIFO WORKING PAPER NO. 934 CATEGORY 1: PUBLIC FINANCE APRIL 2003
An electronic version of the paper may be downloaded • from the SSRN website: http://ssrn.com/abstract=404581 • from the CESifo website: www.CESifo.de
CESifo Working Paper No. 934
IRREVERSIBLE INVESTMENTS AND REGULATORY RISK Abstract This paper addresses the issue of how regulatory constraints affect 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 that we have 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 negatively investment decisions. 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. JEL Code: L51, D92, G31. Keywords: regulation, investment, RPI-x, profit sharing.
Paolo M. Panteghini University of Brescia Department of Economics Via San Faustino 74/B 25122 Brescia Italy
[email protected]
Carlo Scarpa University of Brescia Department of Economics Via San Faustino 74/B 25122 Brescia Italy
[email protected]
We would like to thank Giacomo Calzolari, Vesa Kanniainen, Pia Koskenoja, Michele Moretto and participants to seminars at the Universities of Bologna, Helsinki and Padova, at CESifo in Munich and at the RES Conference in Warwick for comments on earlier drafts.
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