Contents ................................................................................................... IX
1 Introduction.............................................................................................1
2 Basic Elements for a Comprehensive Concept of Regulatory Risk –
Models, Objectives, Process, Cost Concepts and Types of Rate
Regulation...................................................................................................9
2.1 Characterization of the Two Basic Models of Rate Regulation .......9
2.1.1 Monopolistic Model of Rate Regulation ...................................9
2.1.2 Competitive Model of Rate Regulation...................................10
2.2 Systematization of the Objectives and Principles of
Rate Regulation ....................................................................................11
2.3 Characterization of the Cost-Orientated Rate Setting Process .......14
2.4 Comparison of the Role of the Cost of Capital in Different
Cost Concepts of Rate Regulation........................................................16
2.5 Comparison of the Role of the Cost of Capital Under Different
Types of Rate Regulation .....................................................................18
2.6 Comparison of the Role of the Cost of Capital and the Rate of
Return in Regulated and Non-Regulated Firms....................................19
2.7 Characterization of Regulatory Risk ..............................................21
3 Impact of Rate Regulation on the Risk of a Regulated Firm............23
3.1 Development of a Framework of Rate Regulation for the
Analysis of Regulatory Risk.................................................................23
3.2 Analysis of Circularity and (Time) Inconsistency as
Fundamental Problems of Rate Regulation ..........................................27
3.3 Systematization and Analysis of the Effects of Rate Regulation
on the Risk of a Regulated Firm ...........................................................32
3.3.1 Elimination of Risk by Rate Regulation? ................................34
X Contents
3.3.2 Increase or Decrease of (Systematic) Risk by
Rate Regulation? ..............................................................................35
3.3.3 Asymmetric Regulatory Risk ..................................................40
3.4 Systematization and Analysis of the Transmission Paths of the
Effects of Rate Regulation on the Risk of a Regulated Firm................44
3.4.1 Direct Impact of Rate Regulation on Risk...............................45
3.4.2 Indirect Effects of Rate Regulation via Adjustments of
Investment and Financing.................................................................45
4 Development of a Regulatory Control Panel – Analysis of
Individual Variables of Rate Regulation as Determinants of
Regulatory Risk .......................................................................................55
4.1 Impact of the Overall Regulatory System Variables on Risk.........57
4.1.1 Profit Elements Covered by Rate Regulation..........................57
4.1.2 Regulatory Review Period and Regulatory Lag ......................60
4.1.3 Degree of Regulatory Discretion.............................................63
4.1.4 Bandwidth Within Which the Actual Rate of Return
Can Vary...........................................................................................65
4.2 Impact of Regulatory Accounting Directives on Risk....................72
4.2.1 Regulatory Cost Concept.........................................................72
4.2.2 Accounting Directives Determining Operating Expenditures.74
4.2.3 Accounting Directives Determining Capital Expenditures .....77
4.2.4 Impact of the Cost Distribution Base on the Capacity
Utilization Risk.................................................................................98
4.3 Impact of Variables Determining the Scope of Regulation............99
4.3.1 Scope of Regulated Decisions ...............................................100
4.3.2 Scope of Regulated Firms......................................................105
4.3.3 Scope of Regulated Markets..................................................111
4.4 Case Study: California Energy Crisis as the Result of an
Incompatible Combination of Regulatory Variables ..........................114
5 Determination of the Regulatory Rate Base.....................................119
5.1 Characterization of a Hypothetical Benchmark System of
Rate Regulation Establishing Equality of Book Values and
Market Values.....................................................................................120
5.1.1 Consistent Treatment of the Regulatory Rate Base,
Depreciation, and Interest...............................................................121
5.1.2 Inclusion of New Investment in the Regulatory Rate Base ...141
5.1.3 Investments Accounted for as Operating Expenditures.........142
5.2 Explanation of Deviations of Market Values from Book
Values in the Case of Rate-Regulated Firms - Rationale for
Using Book Values in the Regulatory Rate Base ...............................143
Contents XI
5.2.1 Deviations Due to Characteristics of Real Systems of
Rate Regulation ..............................................................................144
5.2.2 Deviations Due to Future Investment Possibilities After an
Anticipated Phasing-Out of Rate Regulation .................................150
5.2.3 Deviations Due to Activities in Non-Regulated Business
Divisions.........................................................................................151
5.3 Reconciliation of the Use of Book Values in the Regulatory
Rate Base with the Return Required by Investors ..............................152
5.3.1 New Private Investments .......................................................154
5.3.2 Existing Private Investments .................................................154
5.3.3 Privatization of Public Enterprises ........................................157
6 Market-Based Assessment of the Cost of Capital for a Rate-
Regulated Firm ......................................................................................163
6.1 Identification of Specifics of Cost-Orientated Rate Regulation
Relevant for Cost of Capital Assessment ...........................................165
6.2 Assessment of the Input Parameters of Cost of Debt and
Cost of Equity.....................................................................................167
6.2.1 Risk-Less Interest Rate ..........................................................167
6.2.2 Risk Premium for Debt..........................................................169
6.2.3 Market Equity Risk Premium................................................170
6.2.4 Beta Factor.............................................................................173
6.2.5 Beta Factors for Non-Listed Rate-Regulated Firms or
Divisions.........................................................................................177
6.3 Weighting of the Cost of Equity and the Cost of Debt with
the Capital Structure ...........................................................................181
6.3.1 Components of the Capital Structure.....................................181
6.3.2 Actual Versus Optimized Capital Structure ..........................183
6.3.3 Temporal Dimension of the Capital Structure.......................185
6.4 Accounting for Income Taxes in the Cost of Capital ...................186
6.4.1 Narrowing down the Object of Investigation to
Definitive Corporate Income Taxes ...............................................186
6.4.2 Accounting for Definitive Corporate Income Taxes Under
Current German Tax Law...............................................................188
6.4.3 Critical Discussion of the Formula-Based Conversion of
a Post-Tax into a Pre-Tax Rate of Cost of Capital .........................189
7 Conclusions..........................................................................................193
References...............................................................................................199
Index........................................................................................................219