Real Options and the Regulation of Brazilian Fixed-Line Telephone Operators: The Mark-up on the Cost of Capital

Abstract

This study argues in favour of the real option methodology to calculate the access price for Brazilian fixed-line phone operators. The new cost-oriented regulatory framework for interconnection of telecommunication networks established in 2005 poses questions regarding the adequate remuneration of investments. By investing in a fixed-line telephone network while giving access to new entrants the incumbent is actually providing an option to access its infrastructure. Since options aren't costless to properly compensate the investment an effort to estimate the option premium is justified. We suggest a pragmatic approach where the real options rationality appears as a mark-up over the sector's cost of capital. Failing to consider the real option granted by incumbents discourages investment in infrastructure in the sector and hinders the intertemporal maximization of social welfare.