A Game Theoretic Analysis of Alternative Institutions for Regulatory Cost-Benefit Analysis

This paper uses the tools of game theory to explore a number of issues regarding regulatory agency incentives. It models notice-and-comment rulemaking as a sequential game and employs that model to examine how a regulatory agency's incentives to consider both regulatory costs and benefits are likely to vary with statutory type - whether or not the statute explicitly requires that regulatory standards be set on the basis of cost-benefit analysis - and the procedural structure of OMB review. The sequential game model explicitly distinguishes between lobbying and litigation as strategies that regulatory targets may employ in attempting to defeat regulation. Among the non-intuitive insights generated by the model are the following: 1) even when there is no statutory obligation to consider regulatory compliance costs, the fact that a regulatory target's lobbying and litigation effort level increases in its expected compliance cost itself provides regulatory agencies with an incentive to choose cost-effective regulation; 2) when the judicial review process is costly and complex, the regulator may choose not to regulate if it learns that the regulatory target has high compliance cost, and in this situation, such a target may reveal its (compliance cost) type in a separating equilibrium at the lobbying stage; 3) if the court is perfect in reviewing a substantive cost-benefit statute (one that says regulation is to proceed only if benefits exceed costs), then revising statutes to include such substantive cost-benefit requirements may enhance rather than reduce the incentive for regulatory targets to politicize regulatory costs at the lobbying stage; 4) by highly rewarding at the judicial review stage agency efforts to learn regulatory compliance cost ex ante, procedural cost-benefit statutes (such as NEPA, the National Environmental Policy Act) maximize agency incentives to learn costs ex ante and thus may have surprisingly large effects in cutting the volume of regulation; 5) to the extent that OMB review is equivalent to a preliminary lobbying stage in which lobbying by beneficiaries is constrained, it gives regulatory targets the opportunity to impose large political penalties on the agency at relatively low cost, but opening up the OMB process to make it easier for regulatory beneficiaries to lobby OMB would likely have relatively little effect on Executive branch behavior, since OMB is used selectively based on Presidential party and preferences