A Theory of Government Regulation and Self-Regulation with the Specter of Nonmarket Threats
We develop a game-theoretic model wherein a government establishes a mandate for product quality without possessing effective enforcement abilities, and a firm chooses whether to ignore, comply with, or exceed the government quality standard. After bringing a product to market, the firm faces the possibility of nonmarket reactions by interests such as trial attorneys and consumer activists, who might sue in the case of product-induced damages or reveal the firm’s quality choice to consumers through investigatory and publicity activities. Equilibrium results identify conditions under which firms will engage in meaningful selfregulation, either by voluntarily selecting a high-quality standard for their product absent a government mandate, or by complying with a government mandate for high quality even though government lacks enforcement power. Our results have direct implications for how political actors choose to regulate certain industries based on the market value of different products, on the danger associated with various products, and on the nature of the nonmarket environment.