Discouragement through incentives

Incentives are usually designed to promote desirable behaviour. In many instances, however, even in the absence of an incentive scheme, people may deliberately choose to act as desired. In such a case, introducing a system of incentives may discourage people from doing this. The discouragement mechanism works through the possibility of errors that may wrongly classify the observed behaviour as undesirable, and hence trigger penalties. The effect is amplified by pessimism, which leads to an overestimation of the error probability, and by the disappointment from errors, which increases the disutility of unfair penalties. This approach is capable of explaining two typical observations for enterprises/industries subject to environmental regulation – overcompliance (excessive investment in compliance) and discretionary inspections by regulators (raised frequency of inspections to enterprises suspected of non-compliance).