Alternative Rate of Return Concepts and Their Implications for Utility Regulation

Ezra Solomon

Bell Journal of Economics, 1970, vol. 1, issue 1, 65-81

Abstract: The rate of return on invested capital is a widely used concept in both regulated and unregulated sectors of the economy. It provides a measure of actual performance as well as required or expected performance (the latter is often termed the "cost of capital"). In the utility field, regulatory agencies often focus on the rate of return as a major instrument for assessing and controlling the performance of firms under their jurisdictions. Unfortunately, two altogether distinct units are employed for measuring rate of return: (1) book rate units and (2) discounted cash flow units. Rarely will the two produce the same result, and the use of one measure as a surrogate for the other may prove highly misleading. This paper indicates the relationship between the two measures and shows the impact of some variations in depreciation and expensing procedures, growth rate, etc. The object is to point out the potential hazards associated with the use of measures of different things in a context that requires the use of measures of the same thing.

Date: 1970
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