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Third‐party access to major infrastructure facilities is a key component of National Competition Policy. In many situations, both through state regimes and access undertakings under the new part IIIA of the Trade Practices Act, access will be governed by explicit or implicit rate‐of‐return procedures. Infrastructure assets will be valued and translated into an allowable return for the owners. However, setting allowed returns is only the first part of the regulatory process. This paper uses a simple model to evaluate the 'second‐best' access prices under rate‐of‐return regulation. We show that optimal access prices will depend on the degree of downstream competition. With imperfect price competition and fixed numbers of firms downstream, optimal access prices will 'mimic' downstream competition and reduce downstream profits. With free entry downstream, optimal access pricing should determine an optimal level of downstream participation. We also show that the access provider's incentives to introduce optimal access prices will depend on the degree of vertical integration.

This paper is concerned with formulating directional distance functions assuming that firms operate subject to rate-of-return regulation. To this end, we consider two different contexts. First, we assume that input prices are known, which allows us to extend the rate of return regulated version of Farrell efficiency. Secondly, we assume that input prices are unknown, showing then that a specific reference direction arises as a natural choice for measuring efficiency with directional distance functions.

I The Institutional Setting for Rate of Return Determination -- 1 Rate of Return in Rate Cases: The Institutional Setting -- 2 Earned Rates of Return, Allowed Rates of Return and the Cost of Capital in a Historical Setting -- II Theory of Rate of Return Determination -- 3 Traditional Models: DCF and Comparable Earnings -- 4 Traditional Models: CAPM and Risk Analysis -- 5 Recent Models: Arbitrage Pricing Theory -- 6 Recent Models: Valuation of Contingent Claims and Regulation -- 7 Issues in the Theory of Rate of Return -- III Methodologies for Rate of Return Determination -- 8 Methodology of Comparable Earnings and DCF -- 9 The Methodology for Risk Analysis -- 10 Methodology of Arbitrage Pricing Theory -- 11 Issues in Methodology for Determining the Rate of Return -- IV Judgment and Rate of Return Determination -- 12 The Past and the Present: Adapting to Change -- 13 Factors Not Incorporated into the Models -- 14 The Reliability of Rate of Return Judgment -- 15 Beyond Rate of Return Regulation -- References -- List of Symbols.

Cover -- Half Title -- Dedication -- Title -- Copyright -- Contents -- List of Tables -- List of Figures -- Acknowledgements -- Introduction -- The Research Question -- Outline -- 1 Rate-of-Retum Regulation -- 1.1 Rate-of-Retum Regulation in the Gas, Telephone, and Electric Industries -- 1.2 The Historical Development of Rate Regulation -- 1.3 Rate-of-Retum Regulation in Action -- 1.3.1 Revenue Requirement Phase -- 1.3.2 Rate Design Phase -- 2 The Averch-Johnson Model -- 2.1 The Averch-Johnson Effect -- 2.2 A Geometric Treatment -- 2.3 Extensions of the Averch-Johnson Model -- 2.3.1 Regulation Lags -- 2.3.2 Non-Profit Maximization -- 2.3.3 The Cost of Capital and the Allowed Rate-of-Retum -- 2.3.4 Induced Technical Change -- 3 Augmented Averch-Johnson -- 3.1 Augmented Averch-Johnson -- 3.2 Extension on Factor Augmentation with R&D Spillovers -- Appendix: Note on Neoclassical and Endogenous Technology -- A.3.1 Neoclassical Production Functions with Technology -- A.3.2 Endogenous Growth Production Functions -- 4 Research Joint Ventures -- 4.1 Noncooperative R&D and Output -- 4.2 Cooperative R&D and Noncooperative Output -- 4.3 Cooperative R&D and Output -- 4.4 Discussion -- 5 Evidence From Electric Utilities in Texas -- 5.1 Translog Cost Model -- 5.2 The Data -- 5.3 Estimation and Results -- 5.4 Summary -- Appendix: Pooled Model -- 6 Implications and Conclusions -- 6.1 Welfare Implications -- 6.2 Next Step -- Bibliography -- Index