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Dynamics of rate-of-return regulation

Nezlobin, Alexander, Rajan, Madhav V. and Reichelstein, Stefan (2012) Dynamics of rate-of-return regulation. Management Science, 58 (5). 980 - 995. ISSN 0025-1909

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Identification Number: 10.1287/mnsc.1110.1464

Abstract

Under rate-of-return regulation, a firm's product prices are constrained by the requirement that investors not earn more than an allowable return on the firm's assets. This paper examines the dynamic properties of the rate-of-return regulation process when the regulated firm periodically undertakes new capacity investments. Our analysis identifies prices that correspond to stationary values of the regulation process. It is shown that the underlying depreciation rules for property, plant, and equipment determine whether these stationary prices will be above, equal to, or below the long-run marginal cost of providing the regulated service. We provide conditions under which the rate-of-return regulation process is dynamically stable so that prices indeed converge to their stationary values. The overall efficiency of this regulation method is shown to depend on how well the applicable depreciation schedule matches the productivity pattern of the assets in use.

Item Type: Article
Official URL: https://pubsonline.informs.org/journal/mnsc
Additional Information: © 2012 INFORMS
Divisions: Accounting
Subjects: H Social Sciences > HF Commerce > HF5601 Accounting
H Social Sciences > HG Finance
Date Deposited: 04 Nov 2019 12:27
Last Modified: 20 Oct 2020 05:54
URI: http://eprints.lse.ac.uk/id/eprint/102355

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