This paper investigates causes and types of inefficiency problems of the  rate-of-return regulation currently instituted in Korean electricity industry. The inefficiency problems inherent in profit-level R-o-R regulation are numerous such as the Averch-Johnson effect and X-inefficiency and agency problems.

This paper suggest a shift from profit-level rate-of return regulation to price-level regulation since the latter is theoretically more efficient regulatory  mechanism than the former. Under rate-or-return regulation, the regulated firm is largely indifferent to cost increase and lacks incentives to strive for cost efficiency. By breaking the equations between the firm's actual internal costs and allowed revenues, price level regulation regenerates the managerial incentives for profit maximization. once the maximum price level constraints or ceiling is set as in price cap regulation, the regulated firm loses cost enhancing moral hazard incentives and loses control over revenue enhancing efforts as Hillman and Braeutigam mentioned. The regulated firm's profit maximization becomes mainly a matter of cost minimization.  In this respect the goals of productive efficiency, profit maximization and social welfare can be well achieved. This paper investigates also various types of incentive-oriented electricity pricing methods and suggests price-cap regulation.

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