How Academics Can Improve Regulatory Inspections

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Workshop shares research findings to advance agency compliance and enforcement practices.

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U.S. federal lawmakers first agreed to sequestration, a budget process that severely cut spending for government programs, nearly four years ago. Since then, congressional budget fights have dominated headlines as limited funding continues to challenge regulators charged with implementing a variety of federal laws.

To assist agencies facing stiff resource constraints, participants in a workshop hosted this summer by the University of Maryland’s Center for Economics and Policy and Harvard Business School considered how academic research could help agencies achieve better regulatory enforcement and compliance with less funding. The workshop brought together researchers and agency experts to examine three investigation and compliance strategies agencies must navigate: which organizations to target, methods of enforcement, and staffing decisions surrounding who carries out inspections.

Effective targeting begins with matching a selection method to a type of goal, according to Mark A. Cohen of Vanderbilt’s Owen Graduate School of Management. Targeting, or identifying firms the agency believes exhibit a high risk of non-compliance, works well under regulatory schemes focused on achieving maximal compliance across an industry. Other regulations, however, aim to minimize total externalities (costs not borne by the firm receiving the benefits). For example, reducing the total gallons of oil spilled into the ocean focuses on an externality. In contrast, nitoring shipping firms to ensure cargo ship safety standards concentrates on compliance. Random port patrols have substantially reduced the volume of oil spilled, better matching the targeting technique to the externality-reduction goal.

Cohen also shared which company characteristics offer violation clues to regulators. He argued that research indicates that firms in financial distress and those with a history of noncompliance make prime targets for inspection. Companies with a strong commitment to quality and compliance are less productive targets because they are less likely to violate regulatory standards. (Volkswagen’s recent admission of emissions violations, discovered after the Maryland-Harvard workshop, would appear to raise questions about this conclusion.) Cohen reported that research is inconclusive about other possible violation proxies, including the number of plants the company owns, the company’s state of incorporation, and its ownership structure.

After settling on which firms to target, workshop participants considered what are the most effective methods of regulatory enforcement. Professor Jay P. Shimshack of University of Virginia’s Batten School of Leadership and Public Policy addressed this question by sharing lessons from his research and that of other scholars. Building on a longstanding theory of the economics underlying illegal actions, Shimshack explained how firms balance anticipated punishment and benefits when making compliance decisions.

Regulators can amplify enforcement actions against individual firms with this simple benefit-cost framework, inspiring compliance efforts among other companies in similar jurisdictions and industries. Because perceived—as opposed to actual—likelihood of enforcement informs violation decisions, publicity offers regulators a cost-effective strategy. Shimshack also reminded agencies not to discount the merits of positive publicity. Promoting compliance or “good behavior” as the norm can trigger a spillover effect similar to the consequences of a targeted investigation.

With the selection and enforcement strategies in place, agencies must also weigh the human element: inspectors themselves. Jodi L. Short, a professor at University of California Hastings College of Law, presented findings on the relationship between violation detections and inspector behavior. Short encouraged agency employees to envision the regulator’s role as a “consultant” rather than a “cop.” For example, clear communication by individual inspectors can reduce regulatory violations. In a study of small restaurants, 43% erroneously believed their practices complied with regulations. This proportion decreased when inspectors clearly explained the rules. In another study, regular contact among construction managers and regulators increased the likelihood of self-reported violations.

Short’s own study of supply chain inspection teams revealed that fresh eyes matter: experienced teams conducting their first inspections uncovered more violations than similarly qualified inspectors who knew the companies well. Short also found inspection teams that included at least one woman detected violations at higher rates than all-male teams.

Regulatory effectiveness hinges on government agencies maintaining a well-trained, highly capable workforce. The Maryland-Harvard workshop provided an opportunity for dialogue among regulators and academics who hope to improve regulatory compliance and inspection processes in the face of ongoing budgetary challenges.