Reputation and the Control of Pollution

This paper investigates the effectiveness of reputation in inducing a polluting firm to selfregulate its emissions when consumers have imperfect information. In particular, we ask to what extent must consumers reward and punish the firm before it chooses self-regulation as its dominant strategy? We find that if payoffs in the stage game are such that both the consumer and the polluting firm have beliefs that are consistent with each others’ behaviors, then the firm has a positive probability of playing clean in each period of a finite game. Further, we find that a weak reward/punishment scheme may have an adverse effect on the environment, and that there are both environmental and welfare gains associated with strengthening the scheme.