Regulatory Discretion and Compliance

This paper provides an empirical framework to evaluate regulatory discretion and apply it to California water quality regulation. We identify and estimate an adverse selection model of the regulator-discharger interaction to measure the extent to which the regulator’s environmental preferences and administrative or political costs affect penalties and compliance. We find that if the regulator preferences were homogeneous across dischargers, both violation frequencies and penalties would decrease. However, our estimates show that regulators reflect environmental preferences of local constituents. Moreover, the estimated compliance cost heterogeneity across dischargers is large enough that the regulator expertise to allocate penalties is valuable.