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Abstract:
We extend the economic theory of regulation to allow for strategic self-regulation that preempts political action. When political "entry" is costly for consumers, firms can deter it through voluntary restraints. Unlike standard entry models, deterrence is achieved by overinvesting to raise the rival's welfare in the event of entry. Empirical evidence on releases of toxic chemicals shows that an increased threat of regulation (as proxied by increased membership in conservation groups) indeed induces firms to reduce toxic releases. We establish conditions under which self-regulation, if it occurs, is a Pareto improvement once costs of influencing policy are included.

Abstract:
We extend the economic theory of regulation to allow for strategic self-regulation that preempts political action. When political "entry" is costly for consumers, firms can deter it through voluntary restraints. Unlike standard entry models, deterrence is achieved by overinvesting to raise the rival's welfare in the event of entry. Empirical evidence on releases of toxic chemicals shows that an increased threat of regulation (as proxied by increased membership in conservation groups) indeed induces firms to reduce toxic releases. We establish conditions under which self-regulation, if it occurs, is a Pareto improvement once costs of influencing policy are included.

Abstract:
Experimental methods are used to study two central components of an incomplete contract: the ex-post process of negotiation, which fixes contract terms and surplus shares in response to stochastic shocks, and the ex-ante process of transaction-specific investment in anticipation of future surplus shares. The 2x2 treatment design features either high or low discount rates in an alternating-offer bargaining setting, and transaction-specific investments that are either commonly observable or private information and thus unobservable. The analysis finds results consistent with the notion that despite random and anonymous matching of contracting parties, and the noncontractability of investments, parties index their surplus sharing agreements to transcation-specific investments when these investments are observable. Parties who invest relatively more tend to receive larger shares of ex-post surplus, in which promotes additional investment and so overcomes PART (author's emphasis) of the underinvestment problem inherent to these sort of sharing contracts. The analysis suggests that relational exchange is possible in settings where individual reputations and frequently repeated contact are absent, and thus supports Macneil's claim that social norms of equity are cental to relational exchange.