Price Caps, Rate-of-Return Regulation, and the Cost of Capital
Author: Ian Alexander and Timothy Irwin Date: 9/1/1996 (PDF, 200KB)
Ian Alexander and Timothy Irwin compare the effect of price cap and rate-of-return regulation on the risk borne by regulated utilities, showing that price cap regulation subjects firms to greater risk and therefore raises their cost of capital. The implication is that firms regulated by price caps must be permitted to earn higher returns. If not, they will be unable to attract new investment capital, and the quality of service will decline.