Seeking Truth for Power : Informational Strategy and Regulatory Policy Making

Whether regulating mutual funds or chemical manufacturers, government's policy decisions depend on information possessed by industry. Yet it is not in any industry's interests to share information that will lead to costly regulations. So how do government regulators secure needed information from industry? Since information disclosed by any firm cannot be retrieved and can be used to regulate the entire sector, industry faces a collective action problem in maintaining silence. While collective silence is easy to maintain if all firms' interests are aligned, individual firms' payoffs for disclosure can vary due to heterogeneous effects of regulation and differing expectations about the regulator's expected actions with or without any given information. This leads to regulators' first strategy: exploit asymmetries in firms' interests in disclosure. Regulators' second strategy comes from their ability to create asymmetries of interest, namely by selectively rewarding or punishing individual firms. Both of these strategies work best when pursued informally, in less visible ways, since other firms can be expected to inflict retribution on a squealer. Although informal relationships have been long deplored due to the risk of regulatory bias or capture, our analysis shows how they can be beneficial to government in playing the information game. This has important implications for regulatory procedure. Since total transparency would detract from government's ability to secure valuable information, administrative law needs to balance between the competing needs of transparency to prevent abuse and opacity to facilitate information exchange. Posted paper, uploaded January 2010, is the published version of the working paper originally posted May 2004