| Abstract: | This paper addresses the problem of designing environmental regulations when firms possess better information about the cost of pollution abatement than regulators. In the regulatory equilibrium derived in the paper, firms are induced to reveal the information they have concerning abatement costs through the judicious use of abatement standard-subsidy combinations. Offering firms a menu of regulatory contracts, each one specifying a required level of pollution abatement as well as a lump sum subsidy to be paid by the regulatory agency to the firm, is shown to be superior to optimal uniform standard-subsidy schemes. By appealing to the revelation principle and employing a second policy instrument (subsidies), albeit a costly one, in conjunction with an abatement standard, the incentive compatible approach to environmental regulation presented in the paper minimizes the economic inefficiency customarily attributable to a lack of initial information regarding pollution abatement costs. |
