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This paper investigates how price regulation under moral hazard can affect a regulated firm's cost of capital. The authors consider stylised versions of the two most typical regulatory frameworks that have been applied over the last decades by regulators: Price Cap and Cost of Service. They show that there is a trade-off between lower operational costs and a higher cost of capital under Price Cap regulation and higher operational costs and lower cost of capital under Cost of Service regulation. As a result, when the extent of moral hazard is not significant, Price Cap regulation generates lower welfare than the Cost of Service regulation.
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