Effect of the Rate of Return Regulation on Optimality of Input Use, Productivity and Profitability of Firms in the Indian Automobile Industry

Important conclusions of the paper are that contrary to theoretical expectation, regulation on rate of return to capital (RORC) did not result in a greater than optimal degree of capital intensity of production of firms. Firms also had an incentive in terms of an increase in profit margin (PTM) to bring about growth in total factor productivity (TFP). After deregulation, because of competitive pressures, there was a negative effect of TFP on PTM of the medium and heavy commercial vehicle producing firms. Though they operated in monopoly markets, firms, in general, did not earn monopoly rent because of the regulation on RORC. However, given lags in adjustment of prices of vehicles to changes in the average cost of production, changes in input prices had a negative effect on PTM. The regulation on RORC was on individual firm basis and was such that in the car segment, a more efficient firm earned a lower PTM.