THE CAPITAL STRUCTURE OF A REGULATED FIRM

We examine the equilibrium price, investment, and capital structure of a regulated firm using a sequential model of regulation. We show that the firm's capital structure has a significant effect on the regulate d price. Consequently, the firm chooses its equity and debt strategica lly to affect the outcome of the regulatory process. In equilibrium, t he firm issues a positive amount of debt and the likelihood of bankrup tcy is positive. Debt raises the regulated price, thus mitigating regu latory opportunism. However, underinvestment due to lack of regulatory commitment to prices persists in equilibrium.