Bargaining in environmental regulation and the ideal regulator

We present a model of environmental regulation in which the stringency of a firm's emissions standard is determined by cooperative bargaining between the firm and a regulator. We show that bargaining can be socially beneficial because it can achieve the first-best outcome. This outcome is never an equilibrium of the noncooperative, Stackelberg game. We also show that the social cost function is not the preferred objective function for a regulator when regulations are determined by bargaining. Social costs are lower with a regulator that attaches more importance to damages and enforcement costs than to the firm's compliance costs. (C) 1996 Academic Press, Inc.