Uncertain penalties and compliance: experimental evidence

We present the results of a series of economic laboratory experiments designed to study the compliance behavior of polluting firms when penalties are stochastic. The experiments consist of a regulatory environment in which university students faced emission standards and an enforcement mechanism composed of audit probabilities and penalties (conditional on detection of a violation). We examine how uncertainty about the penalty affects the compliance decision and the extent of violation with two levels of enforcement: one in which the regulator induces perfect compliance and another one in which it does not. Our results suggest that in the first case, uncertain penalties increase the extent of violations in firms with higher marginal benefits. When enforcement is not sufficient to induce compliance, the uncertain penalties do not have any statistically significant effect on compliance behavior. Overall, the results suggest that a cost-effective design of emission standards should include complete, public information on the penalties for violations.