Relational Voluntary Environmental Agreements when Emissions Are Unverifiable

Environmental regulation and pollution control may clash against the presence of unverifiable tasks, like source specific emissions. To tackle this issue we reshape a voluntary agreement instrument, already available in the received literature, in a dynamic perspective by means of a relational contracting approach. Setting up a Relational Voluntary Environmental Agreement (REA) helps the regulator to solve the unverifiability issue, and may provide polluting firms with the incentives to stick to environmental requirements. In an N firms symmetric context we show that even if emissions are not contractible across firms, so that enforcement cannot be delegated to a third party, if firms themselves are sufficiently patient, a self-enforcing equilibrium, under which the environmental objective is voluntarily met, exists. Finally, the policy analysis reveals that our REA may be welfare-improving with respect to a Voluntary Environmental Agreement on contractible emissions. This occurs when the enforcement cost savings under a relational agreement are larger than the additional social costs related to free riding.