Choices in Regulatory Program Design and Enforcement

June 2, 2015

Christopher Carrigan
Elise Harrington

Download this Research Paper (Penn Program on Regulation)

Executive Summary

Historically, regulators have relied on a select number of strategies in designing and enforcing rules to carry out their statutory authority. Yet, in reality, a wide range of options exists which regulators can use to tailor their regulatory programs to their particular circumstances.

Solving regulatory problems involves considering how to design the regulatory program as well as how to enforce that program once it is in place. This paper considers the substantial diversity that exists both in the regulatory instruments that can be used to achieve regulatory goals and the various ways that regulators might choose to ensure regulatory entities respond to regulatory demands once they are in place.

Regulatory Instruments

In practice, the vast majority of regulatory problems are addressed using either means- based regulation (which specifies the particular technologies to be used by regulated entities to satisfy the regulatory requirements) or performance regulation (which specifies the end goal in terms of a regulatory target or outcome without stipulating how the firm should achieve it). Yet, the regulator also has at its disposal a number of other instrument options:

  • Market-based mechanisms use market signals rather than specific commands to achieve regulatory goals. Options include “corrective” taxes, fees and charges, tradable permit systems, and bonds. Market-based instruments all share the feature that they allow regulated entities the freedom to choose not only their method for achieving regulatory goals but also the extent to which they actually attain these same goals based on their costs of complying.
  • Management-based regulation mandates that regulated entities engage in a planning process to identify hazards and describe how they will minimize and respond to the associated risks. Although management-based approaches attempt to impact firm choices before a problem is identified, they allow firms flexibility in designing their plans and sometimes do not even mandate that regulated entities implement those same plans.
  • Mandated information disclosure requires firms to gather and provide information about their operations but does not oblige firms to respond to the data they make publicly available. Rather, mandated information disclosure attempts to use social pressure, either through public scrutiny or changes in consumer buying behavior to encourage firms improve their regulatory performance.
  • Voluntary programs do not compel firms to comply with any specific requirements. Instead, these programs, which can be developed by the regulator, employ rewards such as certifications, recognition, awards, educational resources, and exemptions from mandatory regulatory requirements to encourage compliance. As a type of voluntary program, self-regulation does not involve the regulator specifically but often operates to dissuade that regulatory agency from imposing stricter requirements.

Regulatory Enforcement

Just as regulators have a wide variety of instruments at their disposal to craft regulatory programs, they also have a great deal of flexibility in designing their enforcement strategies. In fact, developing an overarching enforcement program requires decisions along a number of dimensions, each of which afford the regulator choices in how they interact with their regulated entities “on the ground.”

  • The level of stringency (or the degree to which requirements mandate “significant” changes in firm behavior) that regulated firms face is determined not only by the regulatory requirements themselves, but also by how they are implemented in practice. Inspectors may rationally choose different levels of stringency over time and across geographies given the diversity in how a regulatory problem manifests itself along these dimensions.
  • Given limited enforcement resources, regulators can use targeting, focusing their enforcement efforts on those firms with poor compliance histories by imposing larger fines and engaging in more frequent inspections. In doing so, firms that are compliant have an incentive to remain so to avoid being targeted while non-compliant firms are encouraged to improve their regulatory performance to escape the targeted group.
  • All regulators seek to achieve deterrence, dissuading violations through the threat of punishment, but the types of deterrence emphasized by the regulator will have implications for how it designs its enforcement programs. Whereas absolute deterrence aims to prevent all violations, optimal deterrence seeks to prevent only inefficient breaches. Contrasting specific deterrence, which looks prevent repeat offenses, general deterrence uses broad threats or actions against one firm to dissuade others from noncompliance.
  • A regulator also has options when it comes to its regulatory style. While regulatory styles are perhaps best thought of along a continuum, the research literature distinguishes between specific types, any of which can be appropriate depending on the specific characteristics of the associated regulatory environment.
  • Legalistic enforcement is a deterrence-based approach which relies predominately on strict, rule-based application of notices, fines, and other mechanisms to sanction infractions and deter future violations.
  • Accommodative enforcement seeks to achieve compliance (not deterrence) by cooperating with and advising regulated entities through informal mechanisms such as education, negotiation, sympathy, and persuasion.
  • Flexible or responsive enforcement (which is sometimes considered synonymous with accommodative enforcement) approaches its interactions with firms by employing a “tit-for-tat” strategy, in which inspectors cooperate when firms do likewise but impose sanctions – often in an escalating fashion – when the regulated entities violate the rules.

The breadth of regulatory instruments and enforcement strategies covered in this paper does not lend itself easily to broad generalizations. However, the large literature examining these regulatory choices yields two general insights which underscore the advantages that those regulators which have a working knowledge of the various possibilities are afforded in designing and enforcing their regulatory programs.

The first is insight is that although all regulatory approaches can achieve some of the goals that a regulator may have for its regulatory programs, no one approach can achieve them all simultaneously. Possible criteria upon which a regulator may base its approach include its ability to reduce risk, cost-effectiveness, relative efficiency, flexibility, administrative feasibility, propensity to promote equity, and ability to mitigate the potential for regulatory capture. For example, the evidence reviewed suggests that market-based instruments offer the potential for achieving regulatory goals more cost effectively than other approaches, but they may so by imposing a greater administrative burden on both the regulator by requiring them to craft more intricate requirements and the regulated entities which might need to implement more complex monitoring equipment as a result. Similarly, although targeted enforcement can achieve compliance more cost-effectively, the discretion such an approach requires of the regulator opens it up to greater interest group pressure.

The second insight is that regulatory approaches can be fruitfully used in tandem to encourage better regulatory performance among regulated entities. Perhaps the clearest illustration of this insight can be found in responsive regulation, which blends legalistic and accommodative enforcement approaches to attempt to realize the advantages of supportively interacting with regulated firms while maintaining the ability to sanction those that attempt to take advantage of the regulator’s willingness to cooperate. Research on regulatory instruments illustrates similar advantages in combining approaches. Some of the most definitive evidence that alternative approaches including voluntary programs can be successful in achieving regulatory goals has come when these instruments were paired with more traditional mechanisms. For instance, research considering the efficacy of mandated information disclosure has shown that it can affect firms’ regulatory performance when used to supplement traditional regulatory mechanisms by making infractions public.

These insights point to a need for the regulator to determine, prior to selecting a regulatory approach, which criteria among the possible set for evaluating regulatory instruments and enforcement methods is most appropriate for its regulatory context. The findings simultaneously underscore the need for the regulator to consider a wide range of potential options before settling on one or more specific approaches. In so doing, the regulatory agency is not only much more likely to choose the option most suited to remedy the problem at hand, but that agency is also more apt to be able to realize the potential synergies available when regulatory instruments and enforcement techniques are used in combination.