Regulating corruptible certifier behavior

Abstract

We investigate how to regulate a potentially corruptible certifier considering a situation in which a short-lived firm can acquire a quality label from a long-lived certifier. Such a label can be acquired by investing in quality or bribing the certifier. The unregulated certifier behaves honestly only when the discount factor is sufficiently high, while for lower discount factors, maximizes the size of a bribe by setting the quality standard at maximum. With careful regulation of labeling fee and quality standard, the regulator can reduce corruption, increasing sustainability of the certification market. When a partial certifier capture occurs in equilibrium, a trade-off between static and dynamic social surplus may arise. Maximizing static social surplus without considering the sustainability of the certification market may lead to lower dynamic surplus. In a capture-proof equilibrium, the optimally regulated fee is higher than the inspection cost and the optimally regulated standard is below its unconstrained-by-capture-concerns level. The fee may be increased and the standard reduced as deterring capture becomes more difficult due to a lower discount factor.