Rate-of-return regulation

Rate-of-return regulation is a system for setting the prices charged by government-regulated companies like public utilities. It attempts to set prices at efficient (non-monopolistic, competitive) levels equal to the efficient costs of production, plus a government-permitted rate of return on capital.

Rate-of-return regulation is similar, but not identical to, cost-based or profit margin regulations, in which a company's maximum profit margin is capped. Margin caps are often criticized by economists for encouraging cost-padding or gold-plating, in which a regulated monopoly takes on unnecessary costs to receive additional payment. A similar effect, known as the Averch–Johnson effect, encourages firms under rate-of-return regulations to adopt capital-labor ratios that are too high.

Rate-of-return regulation was dominant in the US for a number of years in the government regulation of utilities. Profit margin caps are still used in health insurance.