Risk and the Form of Regulation

  • Project Overview

The form of regulation affects and allocates risks amongst the regulated firm, its customers, and taxpayers. If the form of regulation transfers risk away from the firm and to customers (or vice versa), then the regulator should adjust the firm’s cost of capital to reflect the reallocation of that risk.

At present, decisions on the cost of capital and revenue requirement are made separately from decisions about the form of regulation. There is strong theoretical and empirical evidence that supports the idea that these aspects of regulation should be jointly determined.

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