Ignore, Avoid, Abandon, and Embrace: What Drives Firm Responses to Environmental Regulation?

Abstract

A regulator’s ability to incentivize environmental improvement among firms is a vital lever in achieving long-term sustainability. However, firms can and do respond to environmental regulation in a variety of ways: complying with its intent; avoiding the regulation by offshoring or by abandoning the market; or ignoring the regulation by continuing with entrenched business practices. The path a profit-maximizing firm will choose depends, in part, on the expected cost of noncompliance, which is a product of the regulator’s stated penalty, the likelihood that noncompliant practices are detected, and the likelihood that detected violations are punished. The form of regulatory regime and three important cost thresholds also drive firm response. In this chapter, through examples of regulatory failures and successes, we develop a framework for understanding how these thresholds interact with the type of regulatory regime being considered and the expected cost of noncompliance to determine whether profit-maximizing firms ignore, avoid, or embrace environmental regulation.