Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 2012:11: When do Firms Break the Law in Order to Reduce Marginal Cost? - An Application to the Problem of Environmental Inspection

Jonas Häckner () and Mathias Herzing ()
Additional contact information
Jonas Häckner: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden
Mathias Herzing: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden

Abstract: This study attempts to identify firm characteristics that are important in determining whether or not a specific firm has strong incentives for non-compliance with environmental laws. In particular, we analyze how these incentives are related to the size of the cost reductions associated with non-compliance, business cycle conditions, the degree of product differentiation, market structure, and price versus quantity competition. When cost reductions are non-dramatic, in the sense that they do not lead to monopoly, the following rules of thumb are suggested. 1) Inspection should be intensified during booms, 2) firms that face high costs of compliance should be inspected more intensely and 3)firms that are insulated from competition by product differentiation or by lack of competitors should be inspected more intensely. Although our prime focus is environmental inspection, the theoretical findings readily extends to other similar applications such as VAT fraud and violations against import restrictions. They can also have some bearing on the monitoring of financial markets that are subject to regulation.

Keywords: Environmental Inspection; Market Structure; Product Differentiation; Bertrand; Cournot

JEL-codes: K32; L13; Q58

45 pages, September 20, 2012

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