Rate of Return Regulation:

The rate of return regulation adjusts overall price levels according to the firm's accounting costs and investment. In most cases, the regulator reviews the costs to examine the claim by the firm that it is receiving less than its cost of capital. It can also review the assertion by a group of consumers the actual rate of return is higher than the cost of capital. The rate of return regulation is criticized on the ground that it encourages cost-padding and if the allowed rate of return is too high it encourages adoption of an inefficiently high capital-labour ratio. This is called A verch- Johnson effect. Rate of return regulation was prevalent in the US for many , countries. With deregulation setting in, however, the rate of return regulation is not in use these days; the price-cap and revenue cap regulations are found to have better incentives for firms.