An Asymmetric Information Problem of Environment Quality

Abstract

The environmental quality standards and preferences vary across different regions. Similarly, regulations on the quality standard of the environment will affect profits of local firms across regions in different ways. Therefore, it would not be efficient to impose a nationwide standard for environmental quality by a central agency since in each region the quality level should allow for specific regional characteristics. Setting a specific standard means assigning property rights both to the polluting firms and to those affected by pollution. Our purpose is to derive some normative implications about property rights: because we are in a world with positive transaction costs, property rights have a central role in determining the ultimate use of resources. How should property rights be designed in order to optimally take into account the asymmetric information structure (the information from both side is not balanced, in one side we get less information than the other side)?. The aim of our paper is to assign exclusive property rights, whether to the one party who creates or to the one party who sustains the externality. Specifically, we argue that it is not optimal to leave the decision about the size of the externality entirely to the bargaining process between the two parties. We prove that a benevolent regulator can increase efficiency by setting a standard, yet allowing for renegotiation between the parties affected, thus making it possible to take into account specific preferences. The importance of the standard is that it defines the threat point of the bargaining game, which in turn affects the efficiency of the system. Keywords: Bargaining game; optimization; environmental quality; asymmetric information.