Enforcement Leverage with Fixed Inspection Capacity

We develop a targeting enforcement mechanism in the context of fixed inspection capacity due to budget constraint. A fixed number of firms are selected for inspection and those with the highest emissions are targeted with higher inspection probability. This structure induces dynamic rank-order tournaments among inspected firms. The differentiated inspection probabilities between targeted and untargeted firms induces leverage effects while the rank-order tournament induces competition effect. The combinations of leverage and competition effects give firms more incentive to abate and stay in compliance. We use numerical simulations to show that targeted firms should be inspected with high probability and that about 2/3 of inspections should be allocated to targeted firms. Furthermore, even suboptimal allocations of inspections and firms to the targeted and untargeted groups can out-perform static enforcement schemes.