The Effect of Fines on Regulated Industries

Abstract

A series of papers on regulation and fines utilizes formal analysis to conclude that a firm's compliance with regulation increases when the fines for violation are increased. The common denominator of these papers is the modelling of the firm as a decision-maker under risk: the firm's goal is to minimize expected losses given some probability that it may get caught violating certain regulations. A better approach is to derive these probabilities given that the regulatory agency endeavors to maximize its own gains. Therefore, the agency-firm interaction must be modelled explicitly as a game. If such an approach is adopted, the size of the fine or the level of standards has no impact upon the behavior of the firm under a wide range of conditions. On the contrary, an increase in the fine or a lowering of the standards reduces the frequency with which the agency enforces the law.