Summary This paper proposes an approach to enhance the reliability regulation based on the relative performance. In the proposed approach, the distribution system feeders are clustered based on the parameters, which cannot be controlled by distribution companies. Afterward, a reliability incentive regulation is applied to each cluster so that the performance of each feeder is compared to its counterparts in the same cluster. The quality regulation is designed based on the reward‐penalty mechanism, which penalizes feeders whose performance is worse than a benchmark and rewards those providing a performance higher than the benchmark. Then, the reward and penalty associated to the electric distribution company are determined to summarize the rewards and penalties for all feeders. Having this approach implemented, utilities compete to make more profits by serving customers at higher reliability levels. To assess the effectiveness of proposed method, it is applied to a real distribution network containing 194 feeders.