Self-reporting mechanism for risk regulation

One problem in implementing risk regulation has to do with asymmetries in information between regulators and licensees. A possible solution is to provide incentives (e.g., more lenient standards) if violations (e.g., risk levels above some specified standard) are disclosed voluntarily by regulated firms, rather than being discovered through the regulator's monitoring efforts. This study adapts game-theoretic work in regulatory economics (where firms are usually viewed as being either compliant or non-compliant) to apply to the case of risk regulation (where firms can be described by continuously varying risk levels). This article derives equilibrium solutions for the self-reporting mechanism under different model formulations, and discusses the conditions under which these solutions are better than a traditional direct-monitoring regulatory scheme. For example, when firms can benefit (in the form of reduced costs) by increasing their risk levels, the results show that offering a loosened standard to encourage voluntary disclosure of risk levels is worthwhile only when a sufficiently large proportion of firms is believed to have high risk levels.