Time to Come Clean? Disclosure and Inspection Policies for Green Production

We examine the interplay between two important decisions that impact environmental performance in a production setting: inspections performed by a regulator and noncompliance disclosure by a production …rm. To preempt the penalty that will be levied once a compliance violation is discovered in an inspection, the …rm dynamically decides whether it should disclose a random occurrence of noncompliance. Anticipating this, the regulator determines inspection frequency and penalty amounts to minimize environmental and social costs, performing either random inspections or periodic inspections. We study this problem by developing a novel analytical framework that combines features from reliability theory and law enforcement economics. We …nd that, contrary to common belief, surprising the …rm with random inspections is not always preferred to inspecting the …rm periodically according to a set schedule. We also …nd that the …rm’s opportunistic disclosure timing behavior may lead to a partial disclosure equilibrium in which the substitutable relationship between inspection intensity and penalty is reversed; a threat of increased penalty is accompanied by more frequent inspections. Subject classi…cation: Environment. Reliability: inspection. Games/group decisions: noncooperative. Area of review: Environment, Energy, and Sustainability