Regulatory Risk and the Cost of Capital: Determinants and Implications for Rate Regulation

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Every Book needs Introduction until the reader knows what it is for? The following is a good Introduction of the this book, which taken from the authour's preface:

One of the central objectives of the European Union is the liberalization of markets and, in particular, of utility sectors such as the telecommunications, postal services, and energy sectors. National regulatory systems and authorities are installed in order to control the transition process from monopolistic to liberalized markets. In this process, the determination of
prices assumes a prominent role. As in the relevant network industries capital costs account for the largest share of total costs, this book addresses a central issue of (de-)regulation.

At the same time, a change in the concepts of cost accounting from a traditional, operation-based view, to a more market-based view can be observed in Germany.

These trends form the background for the analysis contained in this book. Burkhard Pedell develops a comprehensive concept for the study of regulatory risk and its implications for cost-orientated rate regulation that is founded in state-of-the-art economic research. The concept includes the major variables of regulation that are relevant to the risk (adjusted cost of capital) of rate-regulated firms and investigates the interdependences between them.

Central problems such as the circularity between regulation and invesCentral problems such as the circularity between regulation and investors' expectations, the commitment of the regulator, the employed depreciation methods and their connection to the interest rate, the determination of the regulatory rate base and the capital market-based assessment of the cost of capital are discussed. Answers to all these problems are given building on modern economic theory and the findings of empirical research. Two prominent results concern the depreciation method and the regulatory rate base: It is shown that, in many situations, depreciation should not be based on historical costs but on used replacement costs. Convincing arguments emphasize that, in a system of rate regulation, the book value of assets, and not market value of capital, should be used in the regulatory rate base.

In this book, the problems associated with the assessment of risk (adjusted cost of capital) for rate-regulated firms are comprehensively discussed. It develops a theoretically and empirically well-founded concept for the determination of cost-orientated prices in such firms. The results presented in this book advance existing research and are well-suited to supporting the process of deregulation. Therefore, they will prove useful both to regulators in European and other countries as well as regulated firms.

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