Abstract
We analyze the rate of return (ROR) regulation that values a firm's assets at their book values, and decompose its effects into three components: the Averch–Johnson (AJ) effect, the capital-gains effect, and the book-valuation effect. We show that the book-valuation effect can upset the AJ effect to cause an underinvestment in capital. We obtain these results using a spatial model with a commuter railway. Next, by simulation, we demonstrate that the book-valuation effect of book-value-based ROR regulation causes Japanese urban railways to underinvest in railroad right of way, which results in extreme congestion during rush hours.
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