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An Experimental Study of Compliance and Leverage in Auditing and Regulatory Enforcement

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  • Timothy N. Cason
  • Lata Gangadharan

Abstract

Evidence suggests that a large majority of firms and individuals comply with regulations and tax laws even though the frequency of inspections and audits is often low. Moreover, fines for noncompliance are also typically low when regulatory violations are discovered. These observations are not consistent with static compliance models. Harrington (1988) modified these static models by specifying a dynamic game in which some agents have an incentive to comply even when the cost of compliance each period is greater than the expected penalty. This paper reports a laboratory experiment based on the Harrington model framework, in which subjects move between two inspection groups that differ in the probability of inspection and severity of fine. Subjects decide to comply or not in the presence of low, medium or high compliance costs. Enforcement leverage arises in the Harrington model from movement between the inspection groups based on previous observed compliance and noncompliance. Our results indicate that consistent with the model, violation rates increase when compliance costs become higher and as the probability of switching groups becomes lower. Behavior does not change as sharply as the model predicts, however, since violation rates do not jump from 0 to 1 as parameters vary across critical thresholds. A simple model of bounded rationality explains these deviations from optimal behavior.

Suggested Citation

  • Timothy N. Cason & Lata Gangadharan, 2004. "An Experimental Study of Compliance and Leverage in Auditing and Regulatory Enforcement," Department of Economics - Working Papers Series 918, The University of Melbourne.
  • Handle: RePEc:mlb:wpaper:918
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    References listed on IDEAS

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    2. Cason, Timothy N. & Gangadharan, Lata, 2006. "Emissions variability in tradable permit markets with imperfect enforcement and banking," Journal of Economic Behavior & Organization, Elsevier, vol. 61(2), pages 199-216, October.
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    Cited by:

    1. Cason, Timothy N. & Gangadharan, Lata, 2006. "Emissions variability in tradable permit markets with imperfect enforcement and banking," Journal of Economic Behavior & Organization, Elsevier, vol. 61(2), pages 199-216, October.
    2. Tan, Fangfang & Yim, Andrew, 2014. "Can strategic uncertainty help deter tax evasion? An experiment on auditing rules," Journal of Economic Psychology, Elsevier, vol. 40(C), pages 161-174.
    3. Lindeboom, Maarten & van der Klaauw, Bas & Vriend, Sandra, 2014. "Audit rates and compliance: A field experiment in long-term care," CEPR Discussion Papers 9924, C.E.P.R. Discussion Papers.
    4. Hennig-Schmidt, Heike & Jürges, Hendrik & Wiesen, Daniel, 2018. "Dishonesty in healthcare practice: A behavioral experiment on upcoding in neonatology," HERO On line Working Paper Series 2018:3, Oslo University, Health Economics Research Programme.
    5. Giorgio Coricelli & Mateus Joffily & Claude Montmarquette & Marie Villeval, 2010. "Cheating, emotions, and rationality: an experiment on tax evasion," Experimental Economics, Springer;Economic Science Association, vol. 13(2), pages 226-247, June.
    6. Takayoshi Shinkuma & Shunsuke Managi, 2012. "Effectiveness of policy against illegal disposal of waste," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 14(2), pages 123-145, April.
    7. Lana Friesen, 2012. "Certainty of Punishment versus Severity of Punishment: An Experimental Investigation," Southern Economic Journal, Southern Economic Association, vol. 79(2), pages 399-421, October.
    8. Gilpatric, Scott M. & Vossler, Christian A. & Liu, Lirong, 2015. "Using competition to stimulate regulatory compliance: A tournament-based dynamic targeting mechanism," Journal of Economic Behavior & Organization, Elsevier, vol. 119(C), pages 182-196.
    9. Lindeboom, Maarten & van der Klaauw, Bas & Vriend, Sandra, 2016. "Audit rates and compliance: A field experiment in care provision," Journal of Economic Behavior & Organization, Elsevier, vol. 131(PB), pages 160-173.
    10. Christian A. Vossler & Scott M. Gilpatric, 2017. "Endogenous Tax Audits and Taxpayer Assistance Services: Theory and Experiments," Working Papers 2017-01, University of Tennessee, Department of Economics.
    11. Bigoni, Maria & Le Coq, Chloé & Fridolfsson, Sven-Olof & Spagnolo, Giancarlo, 2008. "Risk Aversion, Prospect Theory, and Strategic Risk in Law Enforcement: Evidence From an Antitrust Experiment," SSE/EFI Working Paper Series in Economics and Finance 696, Stockholm School of Economics.
    12. Coria, Jessica & Zhang, Xiao-Bing, 2015. "The Harrington Paradox Squared," Working Papers in Economics 608, University of Gothenburg, Department of Economics.

    More about this item

    Keywords

    Regulatory Compliance; Laboratory Experiments; Tax.;

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • Q20 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - General
    • Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy

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