On Social and Market Sanctions in Deterring non Compliance in Pollution Standards

fraud. The aversion of fraud is influenced by the extent of social norms: if the rate of fraud
is rationally expected to be high then the individual cost of being caught while being non
compliant is low ceteris paribus. And conversely. This contrasts with Bontems and Rotillon
(2000) and Heyes (2001) by endogenizing the compliance decisions not only through the
economic incentives provided both by regulatory activities and by markets, but also through
the presence of social norms against frauding behavior.

The analysis yields to multiple instable or stable equilibria for a given enforcement policy
(i.e. for a given penalty and rate of inspection). This explains why some gradual change in
policy may cause a sudden and drastic move in the value that individuals attach to the norm.
We also show that under risk aversion the potential loss in market revenues has an ambiguous
effect on the equilibrium rates of compliance. Similarly, increasing the probability of audit
may decrease the equilibrium rate of compliance when stochastic events make unvoluntary
non compliance possible.

Last, we concentrate on the situation where besides penalties non compliant individuals
may also suffer from market sanctions. The model assumes that consumers are ready to pay
a premium to obtain unobservable environmental attributes. In a context where imperfectly
informed consumers on the “green” market are able to form rational expectations regarding
the extent of illicit activities, multiplicity of equilibria is also obtained. This yields to several
interesting results. First, it is necessary for the regulator to distinguish voluntary from
involuntary non compliance. Second, the amount of information provided to the market
by the regulator (through identifying non compliant products) is crucial and there exist
some conditions for which providing information to the market through public disclosure of
criminal records is welfare decreasing. Last, incorporating the possibility for non compliant
firms to self-report their status before any inspection allows to save audit costs but also
modify the rational expectations of consumers in a sense which is not always desired by a
welfare-maximizing regulator.

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