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Optimal Regulation of Private Production Contracts with Environmental Externalities

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Abstract

We address the problem of optimal regulation of an industry where the production of a polluting output is contracted with independent agents. The provision of inputs is divided between the principal and the agent such that the production externality results from their joint actions. The main result shows that in the three-tier hierarchy (regulator-firm-agent) involving a double-sided moral hazard, the equivalence across regulatory schemes generally obtains. The only task for the regulator is to determine the optimal total fiscal revenue in each state of nature because any sharing of the regulatory burden between the firm and the agent generates the same solution. The equivalence principle is upset only when the effects of regulation on the endogenous organizational choices are explicitly taken into account.

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Correspondence to Philippe Bontems.

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JEL Classification: D82, H23, Q50

We thank Bob Chambers, Emma Hutchinson, David Martimort and Katleen Segerson as well as the participants of the 2nd World Congress of Environmental and Resource Economists, Monterey, 2002; the 2nd Annual Workshop on the Economics of Contracts in Agriculture, Annapolis, 2002; and the 1st CIRANO-IDEI-LEERNA conference on ‘‘Regulation, Liability and the Management of Major Industrial Environmental Risks’’ in Toulouse, 2003 for their comments on previous versions of the paper. Support from the French Ministry of Ecology and Sustainable Development is gratefully acknowledged.

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Bontems, P., Dubois, P. & Vukina, T. Optimal Regulation of Private Production Contracts with Environmental Externalities. J Regul Econ 26, 287–301 (2004). https://doi.org/10.1007/s11149-004-7552-5

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  • DOI: https://doi.org/10.1007/s11149-004-7552-5

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