DEPRECIATION AND PROFITABILITY UNDER RATE OF RETURN REGULATION

This paper examines the widely-held notion that the regulatory approach to setting earnings equalizes the accounting and internal rates of return, and that this condition holds for any depreciation profile. The evidence suggests that the practical usefulness of this proposition for policy-making may be quite limited. This paper also examines the underlying premise-that, because of its relative constancy over time, the regulated rate of return must equal the internal rate of return-and finds that contrary to earlier suggestions, this result does not always hold in the multi-asset case.