Incentive regulation and investment decisions of European energy utilities

This paper investigates whether the investment and financing decisions of a sample of EU energy utilities are affected by the regulatory regimes and whether this influence is sensitive to the firm’s private vs. state ownership. We find that the investment rate is higher under the price cap regime. However, ownership does matter, as both investment and leverage, but also profitability, tend to be higher when the firm is privately controlled. When we account for the effect of specific regulatory measures, we find that investment decisions at energy utilities under rate of return regulation are positively affected by the WACC rate, while investment at firms under incentive regulation (i.e. price/revenues cap) are negatively affected by the level of the X-factor. Moreover, the effect of a change in the X-factor is asymmetric, as investment rates decrease significantly when the Xfactor is raised, but do not increase when the regulator adjusts it downward. This suggests that an increase in the X factor generates a decrease in the ex post returns from investment and additional financial constraints, leading utilities to curb investment plans.