Self-policing in a targeted enforcement regime

Southern Economic Journal, April, 2008 by Sarah L. Stafford

For the deliberate violation I assume that regulations require a facility to abate pollution at a cost of c per period, with abatement costs differing across regulated facilities. (15) If a facility does not abate pollution and is inspected, this deliberate violation will be discovered and the facility will be fined Z. (16) Because lack of abatement can only be detected in the period in which it is committed, if the facility is not inspected, it cannot be fined for its current lack of abatement. Facilities are also subject to a probabilistic event (e.g., a spill) that occurs with probability p and will inadvertently render the facility noncompliant. To discover whether the event has occurred, facilities must conduct an audit at a cost of a. (17) Returning to compliance costs (k) but once remediated the violation cannot be detected by regulators, (18) If the event occurs and a facility does not remediate but is inspected, it is assessed a fine F. For simplicity, let F include the cost of remediation (k) as well as a punitive fine. Alternatively, if the facility discovers the occurrence, remediates, and discloses it to regulators, the facility receives a fine R. Because R does not include the cost of remediation, R k must be less than F. To be consistent with EPA's Audit Policy, facilities must make the disclosure decision prior to an inspection occurring. Facilities cannot disclose deliberate violations to receive a reduced fine.

Each period, regulators receive one of four possible signals about the facility's compliance status:

i. Compliance: The facility is inspected and there are no detected violations.

ii. Violation: The facility is inspected and a violation (deliberate and/or inadvertent) is detected.

iii. Disclosure: The facility discloses an inadvertent violation and there is no deliberate violation (either because the facility abated or because there is no inspection).

iv. No information: The facility does not disclose and there is no inspection.

Note that this information structure assumes that regulators do not distinguish between types of violations for targeting purposes. The transition matrix presented in Table 2 shows the probability that a facility in Group i moves to Group j for the next period given the regulator's signal.

With no information, the facility's group does not change. Facilities in [G.sub.2] that are found in compliance will move to [G.sub.1] with probability g. Facilities found to be in violation will be in [G.sub.2] next period, regardless of their starting point. Finally, facilities that disclose but have not been found to be in violation through an inspection will stay in [G.sub.1] if they begin in [G.sub.1] and will move to [G.sub.1] with probability q if they begin in [G.sub.2]. (19) Assuming that inspection probabilities and fines are constant, as long as future payoffs are discounted by [delta] where 0 [less than or equal to] [delta] < 1, Harrington (1988) shows that the optimal facility policy is a stationary policy and is independent of the initial state of the system.