Rules, Standards and Detection

Abstract

Regulators can adjust penalties to compensate for incomplete monitoring of rule-governed regulated parties, but these adjustments often are unavailable when regulated parties are subject to legal standards. Incomplete monitoring consequently invites greater noncompliance under standards than under rules. A similar logic may apply to the use of complicated rules instead of simple ones.

This paper develops a model that clarifies some of the specific tradeoffs that regulators face in designing standards regimes under incomplete monitoring. The model also permits estimation of the extent to which suboptimal compliance due to incomplete monitoring is likely to result in deadweight loss. Generally speaking, where compliance is inexpensive, an increase in detection rates yields greater benefits than where compliance is costly. In costly compliance cases, greater benefit tends to come from shifting to a more rule-like norm.

Keywords: compliance, regulation, efficiency

JEL Classification: H10, H23, K23, L51