Green Business and Blue Angels

This paper presents a model of a monopolist'svoluntary overcompliance with legal environmentalstandards under asymmetric information about thefirm's environmental impacts. The key assumptions are:the existence of quality premia for environmentalsoundness, a positive but imperfect degree ofmonitoring, and adaptive consumer expectations.Conditions necessary for overcompliance to arise in aprofit-maximizing equilibrium are derived. The effectsof a third-party eco-labeling system are analyzed. Itis shown that the existence of an independent labelingauthority increases the likelihood of overcomplianceto be profit-maximizing. Moreover, firms might have anincentive to lobby for the introduction of such asystem. The effect of consumers' risk preferences andan instrument for preventing ``Greenwash'' (companieslying about their environmental performance) is alsodiscussed.