Abstract
Depreciation schedules allocate capital expenditure over time. Investors are properly compensated under any full depreciation schedule, when the allowed rate of return plus inflation adjustments to the rate base just equal the investors' nominal discount rate. Whether changes in this nominal rate are reflected in adjustments to the rate base or the rate of return, depreciation schedules can be chosen to generate efficient time paths of output prices. Practical limits on depreciation schedules, nominal rates, or information may affect the choice between adjusting the rate base or rate of return for temporal changes in capital cost.
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Associate Professor, Policy Sciences Graduate Program, University of Maryland, Baltimore County. Thanks go to Fischer Black, Margaret Guerin-Calvert, Michael Jensen, and Thomas Spavins for their comments. I especially appreciate the attentive and thorough suggestions from Steven Cox and the referee. As always, responsibility for error rests with the author. Much of this analysis was included in Brennan (1981), available from the author.
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Brennan, T.J. Depreciation, investor compensation, and welfare under rate-of-return regulation. Rev Ind Organ 6, 73–87 (1991). https://doi.org/10.1007/BF00428002
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DOI: https://doi.org/10.1007/BF00428002