Regulatory Compliance under Enforcement Gaps

Abstract

The effectiveness of environmental regulation is limited by the extent to which those regulations are enforced. Profit-maximizing firms will comply with a regulation if the expected net benefits of compliance are greater than the expected net benefits of non-compliance given the limited enforcement capabilities regulators have at their disposal. Analyses in the literature usually assume that regulatory agencies know all of the entities subject to regulation. But constant entry and exit of firms create gaps in agencies’ knowledge of regulated entities. This paper conducts a theoretical and empirical analysis of firms’ compliance strategy when such enforcement gaps are present. Our theoretical analysis indicates that a firm with a sufficiently low probability of being subject to enforcement action will delay compliance. We analyze the effect of enforcement gaps on the compliance protocol development component of regulations empirically within the context of nutrient management regulations in Maryland. The Maryland Department of Agriculture (MDA), which enforces this regulation, relies on a registry of farms that includes less than half of the farm operations in the state. We conduct an econometric analysis using farm-level survey data combined with county-level enforcement data. Our econometric model indicates that the probability of being included in the MDA farm registry is associated with a statistically significant and economically meaningful increase in the probability of being in compliance with nutrient management regulations. This result suggests that enforcement gaps can have a significant effect on the performance of environmental regulations.

Keywords: environmental regulation, enforcement, nutrient management, water quality

JEL Classification: L51, Q58