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Rule versus discretion: regulatory uncertainty, firm investment, and bureaucratic organization

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  • Montagnes, B. Pablo
  • Wolton, Stephane

Abstract

As markets evolve, new regulatory concerns emerge. In response, policy makers 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-founded 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 establish the proper counterfactual that accounts for the indirect effects this article identifies.

Suggested Citation

  • Montagnes, B. Pablo & Wolton, Stephane, 2017. "Rule versus discretion: regulatory uncertainty, firm investment, and bureaucratic organization," LSE Research Online Documents on Economics 67075, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:67075
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    File URL: http://eprints.lse.ac.uk/67075/
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    References listed on IDEAS

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    1. Susan Athey & Andrew Atkeson & Patrick J. Kehoe, 2005. "The Optimal Degree of Discretion in Monetary Policy," Econometrica, Econometric Society, vol. 73(5), pages 1431-1475, September.
    2. Bendor, Jonathan & Meirowitz, Adam, 2004. "Spatial Models of Delegation," American Political Science Review, Cambridge University Press, vol. 98(2), pages 293-310, May.
    3. Daniel Carpenter & Michael M. Ting, 2007. "Regulatory Errors with Endogenous Agendas," American Journal of Political Science, John Wiley & Sons, vol. 51(4), pages 835-852, October.
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    Cited by:

    1. Canes-Wrone, Brandice & Ponce de Leon, Christian & Thieme, Sebastian, 2022. "Electoral Cycles, Investment, and Institutional Constraints in Developing Democracies," IAST Working Papers 22-129, Institute for Advanced Study in Toulouse (IAST).
    2. Breig, Zachary & Downey, Mitch, 2021. "Agency breadth and political influence," Journal of Economic Behavior & Organization, Elsevier, vol. 188(C), pages 253-268.

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    More about this item

    Keywords

    regulation; discretion; delegation; regulatory uncertainty; bureaucracy;
    All these keywords.

    JEL classification:

    • J50 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining - - - General

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