Rule Versus Discretion: Regulatory Uncertainty, Firm Investment, and Bureaucratic Organization
35 Pages Posted: 6 Jan 2015 Last revised: 7 Mar 2016
Date Written: March 5, 2016
As markets evolve, new regulatory concerns emerge. In response, policymakers institute new requirements for private businesses. Because they impose costs and generate uncertainty, these requirements may deter firm investment. To reduce regulatory uncertainty and favor investment, a principal can choose a rule-based regulatory framework. However, unlike discretion, rules do not adapt to circumstances and are thus inefficient. Using a micro-funded model, we uncover circumstances under which the ex-ante certainty provided by a rule dominates the ex-post efficiency provided by delegation to an unbiased agent. We also establish when delegating to a biased agent is optimal for a policy-maker. Our main results highlight that the anticipated economic responses of firms can indirectly influence the organization of the bureaucracy. As such, any attempt to evaluate firms' direct influence in the rule-making process -- through lobbying or information disclosure -- needs to account for the indirect effects we identify when determining the proper counter-factual.
Keywords: Bureaucracy, Bureaucratic Organization, Regulatory Uncertainty, Rule, Discretion
JEL Classification: D70, D73
Suggested Citation: Suggested Citation