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Dynamic Regulation Design Without Payments: Timing is Everything

Author

Listed:
  • Ralph Boleslavsky

    (Department of Economics, University of Miami)

  • David L. Kelly

    (Department of Economics, University of Miami)

Abstract

We consider a two period model of optimal regulation of a firm subject to marginal compliance cost shocks. The regulator faces an asymmetric information problem: the firm knows current compliance costs, but the regulator does not. Both the regulator and the firm are uncertain about future costs. In our basic framework, the regulator may not offer payments to the firm; we show that the regulator can vary the strength of regulation over time to induce the firm to reveal its costs and increase welfare. In the optimal mechanism, the regulator offers stronger (weaker) regulation in the first period and weaker (stronger) regulation in the second period if the firm reports low (high) compliance costs in the first period. Low cost firms expect compliance costs to rise in the future, and thus prefer weaker regulation in the second period. High cost firms expect costs to fall in the future and thus prefer regulation which becomes more strict over time. Thus the regulator offers the low (high) cost firms slightly weaker (stronger) regulation in the second period in exchange for much stronger (weaker) regulation in the first period. We refer to our dynamic mechanism as “timing” the regulation. If the regulator can make payments, then the optimal mechanism to some degree times the regulation as long as a positive cost of funds exists. If the cost of funds is high enough, then under the optimal mechanism the regulator will not use payments and only use our timing mechanism

Suggested Citation

  • Ralph Boleslavsky & David L. Kelly, 2011. "Dynamic Regulation Design Without Payments: Timing is Everything," Working Papers 2011-4, University of Miami, Department of Economics.
  • Handle: RePEc:mia:wpaper:2011-4
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    File URL: http://moya.bus.miami.edu/~dkelly/papers/elicit.pdf
    File Function: First version, 2011
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    More about this item

    Keywords

    regulation design; environmental regulation design; hybrid policies; dynamic contracts.;

    JEL classification:

    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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