Whether regulating mutual funds or chemical manufacturers, government's policy decisions depend on information possessed by industry. But it is not in any industry's interests to share information that will lead to costly regulations. So how do government regulators secure needed information from industry? Since information disclosed by any firm cannot be retrieved and can be used to regulate the entire sector, industry faces a collective action problem in maintaining silence. While collective silence is easy to maintain if all firms' interests are aligned, their payoffs for disclosure can vary due to heterogeneous effects of regulation and heterogeneous beliefs about the regulator's expected actions with or without any given information. The regulator's strategy is therefore to resist or break down industry's collective silence, either by (1) exploiting asymmetries in firms' interests in disclosure, or (2) selectively rewarding or punishing individual firms to create incentives for disclosure. Both of these strategies work best when pursued informally, in less visible ways, since other firms can be expected to inflict retribution on any squealer. Although informal relationships have been long deplored due to the risk of regulatory bias or capture, our analysis shows how they can be beneficial to government in playing the information game. This has important implications for regulatory procedure. Since total transparency would detract from government's ability to secure valuable information, administrative law needs to balance between the competing needs of transparency to prevent abuse and opacity to facilitate information exchange.
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Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number
rwp04-021.