New Zealand Institute for the study of competition and regulation inc.

Abstract

We review the ability of the ex post internal rate of return (IRR) to detect monopoly profits. When market values are used as entry and exit values, the ex post IRR simply reveals whether the firm did better or worse than the market expected at the entry date. It says nothing about monopoly profits. When replacement costs are used as entry and exit values, the ex post IRR can, in principle, reveal something about monopoly profits. However, since the ex post IRR is a noisy measure of ex ante monopoly profits, it will be very difficult to reject the null hypothesis given the sample periods typically available. The benchmarks typically used are market-determined, and therefore only comparable to IRRs calculated using market values - a situation when the ex post IRR reveals nothing about monopoly profits anyway. Furthermore, there is ample empirical and theoretical evidence that these benchmarks do not even represent fair rates of return.