Technology choice and capital structure under rate regulation: a comment

This note identifies and corrects some problems in the analysis of Spiegel [International Journal of Industrial Organization 15 (1997) 191]. In partic ular, it is shown that equity-only regulated firms will want to choose cost structures with strictly positive fixed costs to induce the regulator to s et prices that give strictly positive expected returns. Inefficient technol ogy choice is a costly substitute for taking up debt in the Spiegel and Spu lber [Rand Journal of Economics 25 (1994) 424] model. Regulatory opportunis m may induce both the choice of inefficiently high fixed cost and inefficie ntly high marginal cost technologies. Contrary to Spiegel [International Jo urnal of Industrial Organization 15 (1997) 191] this implies that the intro duction of debt may lead to the choice of technologies with higher or lower fixed costs depending on the available set of technologies. (C) 2002 Elsev ier Science B.V. All rights reserved.