Economics - Research Publications

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Author: Cason, Timothy × Author: Gangadharan, Lata × End date: 2005 × Start date: 2004 × Type: Preprint × Subject: C91 - Laboratory × Subject: Laboratory Experiments ×

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    An Experimental Study of Compliance and Leverage in Auditing and RegulatoryEnforcement
    Cason, Timothy ; GANGADHARAN, LATA ( 2004-09)
    Evidence suggests that a large majority of firms and individuals comply with regulationsand tax laws even though the frequency of inspections and audits is often low. Moreover, finesfor noncompliance are also typically low when regulatory violations are discovered. Theseobservations are not consistent with static compliance models. Harrington (1988) modified thesestatic models by specifying a dynamic game in which some agents have an incentive to complyeven when the cost of compliance each period is greater than the expected penalty. This paperreports a laboratory experiment based on the Harrington model framework, in which subjectsmove between two inspection groups that differ in the probability of inspection and severity offine. Subjects decide to comply or not in the presence of low, medium or high compliance costs.Enforcement leverage arises in the Harrington model from movement between the inspectiongroups based on previous observed compliance and noncompliance. Our results indicate thatconsistent with the model, violation rates increase when compliance costs become higher and asthe probability of switching groups becomes lower. Behavior does not change as sharply as themodel predicts, however, since violation rates do not jump from 0 to 1 as parameters vary acrosscritical thresholds. A simple model of bounded rationality explains these deviations from optimalbehavior.