Comparing Certification and Self-Regulation

I compare certification and self-regulation, two widely used quality assurance mechanisms in markets where consumers do not observe the quality of goods. Certification is a mechanism in which an external firm offers a certificate to producers who undergo a testing procedure, issues the certificate if they meet the certifier's standards and collects the certification fee. Self-regulation is a mechanism in which a club of firms in the industry adhere (or not) to a self-imposed code of conduct and benefit from the club's reputation. I show that if the testing technology is perfect and costless, the choice of standards and fees by the certifying organization (CO) is welfare inferior, while the self-regulatory organization (SRO) chooses a welfare optimal fee, and I identify conditions under which the SRO also chooses optimal standards. If the testing technology is costly and imperfect, this result is not necessarily valid and depends on the difference between the costs of the testing technology available to the CO and SRO