Capping a utility's profit margin can make it build more than it needs
When regulators cap a company's profit as a percentage of its capital, the company's smartest move is to pile up capital, since a bigger capital base justifies a bigger allowed profit. Economists Harvey Averch and Leland Johnson showed in 1962 that this kind of rate-of-return regulation pushes regulated utilities to over-invest past the point of real efficiency. The result is often nicknamed 'gold-plating.'