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Regulation, welfare, and the risk of asset stranding

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  • Guthrie, Graeme

Abstract

Regulated firms are exposed to asset-stranding risk whenever allowed revenue depends on past capital expenditure: if demand falls far enough, past expenditure is unrecoverable. I show that such regulation induces firms to invest in more capital, but distorts the trade-off between investment scale and timing flexibility. Lower allowed rates of return induce firms to invest earlier. Slower regulatory depreciation induces them to invest in larger steps. In order to maximize welfare the allowed rate of return should be set significantly above the cost of capital and the rate of regulatory depreciation significantly above any plausible measure of actual depreciation.

Suggested Citation

  • Guthrie, Graeme, 2020. "Regulation, welfare, and the risk of asset stranding," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 273-287.
    • Handle: RePEc:eee:quaeco:v:78:y:2020:i:c:p:273-287
    DOI: 10.1016/j.qref.2020.04.001
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    Cited by:

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    3. Bigerna, Simona & Hagspiel, Verena & Kort, Peter M. & Wen, Xingang, 2023. "How damaging are environmental policy targets in terms of welfare?," European Journal of Operational Research, Elsevier, vol. 311(1), pages 354-372.

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    More about this item

    Keywords

    Regulation; Investment; Real options; Increasing returns; Averch–Johnson effect;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • L98 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Government Policy

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