The employment of performance based regulation (PBR) in distribution systems could provide some incentive for improving operating efficiency and reducing electricity prices. However, if the PBR mechanism is not properly designed, the enforcement of the PBR may have a negative effect on the supply reliability. In this paper, a mathematical model for optimally setting the parameters of the PBR with a reward/penalty structure is presented, with the minimization of the costs associated with the enforcement of the PBR as the objective and the required reliability level for the distribution system operation as the constraint. Finally, the well-known genetic algorithm is employed for solving the optimization problem. The effectiveness of the approach is demonstrated on a sample example.