A Note on Allowed and Realized Rates of Return in the Electric Utility Industry

Abstract

Most empirical investigations of electric utility behavior use the realized rate of return as a proxy for the allowed rate of return, We examine the validity of this assumption and investigate the relationship of the allowed and realized rates to the cost of capital between 1973 and 1982, We use two measures of the cost of capital: one based on returns to book equity, the other derived from a market price of equity. While realized and allowed rates were generally higher than the book measure throughout the period, both of the rates of return were less than the market price of capital after 1979. We also find firms did not earn their allowed rate of return after 1974. Therefore, the use of the realized rate as a proxy for the allowed rate in empirical models will lead to biased parameter estimates. To help correct this bias, we give data for allowed rates.