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When do Firms Break the Law in Order to Reduce Marginal Cost? - An Application to the Problem of Environmental Inspection

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Abstract

This study attempts to identify firm characteristics that are important in determining whether or not a specific firm has strong incentives for non-compliance with environmental laws. In particular, we analyze how these incentives are related to the size of the cost reductions associated with non-compliance, business cycle conditions, the degree of product differentiation, market structure, and price versus quantity competition. When cost reductions are non-dramatic, in the sense that they do not lead to monopoly, the following rules of thumb are suggested. 1) Inspection should be intensified during booms, 2) firms that face high costs of compliance should be inspected more intensely and 3)firms that are insulated from competition by product differentiation or by lack of competitors should be inspected more intensely. Although our prime focus is environmental inspection, the theoretical findings readily extends to other similar applications such as VAT fraud and violations against import restrictions. They can also have some bearing on the monitoring of financial markets that are subject to regulation.

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  • Häckner, Jonas & Herzing, Mathias, 2012. "When do Firms Break the Law in Order to Reduce Marginal Cost? - An Application to the Problem of Environmental Inspection," Research Papers in Economics 2012:11, Stockholm University, Department of Economics.
  • Handle: RePEc:hhs:sunrpe:2012_0011
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    1. Cohen, Mark A, 1987. "Optimal Enforcement Strategy to Prevent Oil Spills: An Application of a Principal-Agent Model with Moral Hazard," Journal of Law and Economics, University of Chicago Press, vol. 30(1), pages 23-51, April.
    2. Heyes, Anthony & Rickman, Neil, 1999. "Regulatory dealing - revisiting the Harrington paradox," Journal of Public Economics, Elsevier, vol. 72(3), pages 361-378, June.
    3. Garvie, Devon & Keeler, Andrew, 1994. "Incomplete enforcement with endogenous regulatory choice," Journal of Public Economics, Elsevier, vol. 55(1), pages 141-162, September.
    4. Heyes, Anthony G., 1996. "Cutting environmental penalties to protect the environment," Journal of Public Economics, Elsevier, vol. 60(2), pages 251-265, May.
    5. Philippe Bontems & Gilles Rotillon, 2000. "Honesty in Environmental Compliance Games," European Journal of Law and Economics, Springer, vol. 10(1), pages 31-41, July.
    6. Selden Thomas M. & Terrones Marco E., 1993. "Environmental Legislation and Enforcement: A Voting Model under Asymmetric Information," Journal of Environmental Economics and Management, Elsevier, vol. 24(3), pages 212-228, May.
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    1. Häckner, Jonas & Herzing, Mathias, 2017. "The effectiveness of environmental inspections in oligopolistic markets," Resource and Energy Economics, Elsevier, vol. 48(C), pages 83-97.
    2. Häckner, Jonas & Herzing, Mathias, 2020. "The equilibrium compliance rate among regulated firms," International Review of Law and Economics, Elsevier, vol. 63(C).

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    More about this item

    Keywords

    Environmental Inspection; Market Structure; Product Differentiation; Bertrand; Cournot;
    All these keywords.

    JEL classification:

    • K32 - Law and Economics - - Other Substantive Areas of Law - - - Energy, Environmental, Health, and Safety Law
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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