| Abstract: | This paper provides a theoretical analysis of enforcement and compliance decisions when the enforcement process involves significant interaction between a source of violation and enforcer. We show that the comparative static effects of a fine on the probability of a violation consist of a direct effect, which refers to the effect of an increase in the fine on the expected cost of a violation holding the probabilities of enforcementrelated decisions constant, and an indirect effect, which refers to the effect of the fine on the probability of a violation through its effect on the probabilities of enforcement actions taken by the regulator. We show that, in the absence of the indirect effects, an increase in the fine unambiguously reduces the probability of a violation and hence should lead to lower pollution (as expected). However, if the indirect effects are positive and large, an increase in the fine can actually reduce the likelihood that a firm will comply with environmentalregulations. Thus, the increased fines do not necessarily increase compliance incentives. |
