Considerations When Evaluating the Effects of Regulation

The laws and regulations in a market can take different structures. Further, the laws can affect industries and individual companies differently. Therefore, regulation analysts need to understand and predict the impact of proposed new regulations. Similarly, they should analyze varying regulations and project their impact on future expectations of the companies and industries. This analysis enable analysts utilize appropriate valuation tools to come up with fair values for business and investment recommendations.

Steps of Evaluating the Effects of Regulation

1. Assessment of the Possibility of Regulatory Change

A regulatory analyst would need to evaluate the probability of implementing a proposed regulation. To do this, an analyst will have to comprehend the regulator’s objectives, the cost-benefit analysis the regulator has used, and the level of participation of the regulated companies. The analyst might also want to include public and political pressure.

2. Assessment of the Effect of Regulatory Change on a Sector

The analysis incorporates their or an investor’s judgment on the effect of regulations on:

i. Revenues

The regulations in a market might induce limits on the prices, rents, tariffs, and the charged fees to protect consumers. Moreover, certain rules might ban some products or services. Therefore, an analyst would need to approximate the impact of such regulatory interventions on the companies’ income if all entities in the market are affected uniformly.

ii. Cost Effect

Submitting to specific regulations results in an additional cost for companies. For instance, these costs could increase operating expenses for a manufacturing company if the regulation needs the incorporation of new safety aspects or equipment. Therefore, an analyst would need to approximate such costs and include their effect on a company’s anticipated profitability.

iii. Business Risk

Regulations can involve fines, customer compensation, or banning some business activities. Such occurrences are difficult to anticipate. Moreover, the impact of these regulations is hard to quantify. Therefore, an analyst should include such incidents when approximating their probabilities or determining the risk in the discount rate used to determine a company’s value.

Question

The regulatory authority in a country has proposed new regulations on the logistics procedures, limitation of age, and pollution industrial trucks cause. An equity analyst wants to evaluate the effects of these new regulations on a specific manufacturing company. What would most likely be the significant factor for the analyst to consider?

1. The methods and techniques the regulator utilizes in cost-benefit analysis of the regulations.
2. Variation of costs associated with the purchase, operation, and the trucks’ maintenance.
3. The positive effect of decreased pollution on public health and resulting healthcare expenses saving in the broad society.

Solution

The correct answer is B.

The analyst would need to comprehend and analyze the proposed new rules’ effect on the company’s performance.

A and C are incorrect. They are associated with cost-benefit analysis, which the regulatory institution carries out.

Reading 10: Economics of Regulation

LOS 10 (i) Describe the considerations when evaluating the effects of regulation on an industry.