Abstract
The well-known result in the theory of a regulated firm, known as the Averch-Johnson effect, is that a profit-maximizing firm subject to rate-of-return regulation uses an inefficiently high capital-labor ratio to produce its chosen level of output. Numerous contributions in the literature have been instrumental in clarifying the implications and generalizing the model.1 These contributions, however, have been mostly couched within a static framework. Few attempts have been made to investigate the effect of rate-of-return regulation on the dynamic behavior of the firm, in particular its investment plans.2 Neoclassical models of investment often assume that the rate of investment under-
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