Judged in Hindsight: Regulatory Incentives in Approving Innovations

53 Pages Posted: 25 Apr 2020 Last revised: 17 Aug 2020

See all articles by Suraj Malladi

Suraj Malladi

Cornell University, Department of Economics; Stanford University, Graduate School of Business

Date Written: March 31, 2020

Abstract

I study how limited information and ex-post evaluation by third parties affect how regulators design approval rules for innovations. I consider a model in which the regulator designs approval rules to minimize criticism for approval errors and for imposing a costly approval process on innovating firms. This model can explain observed patterns of correlation between firm costs and benefits of approval, why regulators drag their feet on approval decisions even in the face of strong favorable evidence, and support for regulatory sandboxes even if they do not hasten learning. In turn, I consider how a principal (e.g., a politician or legislative body) can optimally delegate authority to the regulator to influence the design of approval rules downstream. The effectiveness and ease of delegation hinge on how the regulator orders the importance of approval errors and costs relative to the principal. When the regulator faces more pressure to reduce errors, the principal suffers no agency costs under the optimal delegation rule. Moreover, this rule takes a simple form and can be implemented without detailed knowledge of the firm's preferences. When the regulator instead faces more pressure to reduce approval costs, the principal cannot avoid agency frictions in general, non-interval delegation rules may be optimal, and the form of these rules are sensitive to the details of regulators' preferences.

Keywords: consumer protection regulation, regret, ambiguity, approval rules

JEL Classification: D81, D82, D86, L51

Suggested Citation

Malladi, Suraj, Judged in Hindsight: Regulatory Incentives in Approving Innovations (March 31, 2020). Available at SSRN: https://ssrn.com/abstract=3565187 or http://dx.doi.org/10.2139/ssrn.3565187

Suraj Malladi (Contact Author)

Cornell University, Department of Economics ( email )

Ithaca, NY
United States

HOME PAGE: http://https://economics.cornell.edu/suraj-malladi

Stanford University, Graduate School of Business ( email )

Stanford, CA
United States

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