Regulatory Capacity and Hard-to-Enforce Requirements

In an asymmetric-regulation model, a firm can comply with two regulatory targets, and a regulator can audit the firm to verify compliance. Inspection by the regulator is imperfect, and it assesses the firm’s compliance with the targets with different success probabilities. In equilibrium, the firm fully complies only if compliance costs are low. Otherwise, the firm always prioritizes the requirement that is easier to enforce. Expanding regulatory capacity positively affects compliance with the easy-to-enforce target; however, enabling the regulator to enforce both targets can harm compliance with the hard-to-enforce target. When the asymmetry in enforceability is high, an increase in regulatory capacity can negatively affect welfare, highlighting novel considerations for optimal regulatory design.

Gambato, Jacopo, Bernhard Ganglmair und Julia Krämer (2025), Regulatory Capacity and Hard-to-Enforce Requirements, ZEW Discussion Paper Nr. 25-050, Mannheim.