Instrument Choice When Regulators and Firms Bargain

We compare outcomes with an emissions tax and an emissions standard when a firm and regulator engage in cooperative bargaining over the stringency of the regulation. Bargaining is motivated by giving the firm a choice of abatement technologies. If the firm's preferred technology differs from the regulator's, the first-best outcome is not an equilibrium of the traditional noncooperative game in which the regulator is a Stackelberg leader. The regulator may therefore choose to offer the firm a more lenient regulation if it agrees to switch technologies. We find that the resulting bargaining outcomes differ for a tax and a standard even though information is symmetric, and we identify conditions under which each instrument yields lower social costs.