Making the Violation Fit the Punishment? Mandatory Disclosure, Discontinuous Penalties, and Inspector Behavior

Mandatory disclosure can regulate product quality, but also motivate manipulation of disclosed information. While information collection by regulatory agents prevents direct manipulation, indirectly, firms may persuade those agents to manipulate. Los Angeles County food-service health inspections are numerically scored—violations deduct from 100—but only letter grades are disclosed. Dubious bunching of scores at 90—the A-grade threshold—has long been evident. In 2017, the county responded with a new rule: committing multiple 4-point violations in an inspection incurs an additional 3-point penalty. While most health-code violations are prescribed a single deduction, a subset carry 2- or 4-point penalties depending on severity. Before the new rule, severity under-reporting in response to letter-grade implications is evident. Among otherwise very similar inspection performances, the new rule introduces letter-grade implications in some contexts, but not others, and difference-in-differences estimates suggest these new letter-grade implications caused a 46% relative increase in lesser-deduction propensity—i.e., severity under-reporting not only persists, it appears to adapts in opposition to the new rule's apparent intent. Response heterogeneity reveals inspectors whose reporting is highly sensitive to, and some whose reporting is insensitive to, letter-grade implications. Interestingly, while the highly-sensitive types exhibit bias favoring firms when letter-grade implications exist, they appear to be the more stringent inspectors, generally. The insensitive types assess the lesser deduction at relatively high frequencies irrespective of letter-grade implications, and comparisons suggest the highly-sensitive types may be more reliable reporters of non-compliance overall.