Regulatory Compliance in the Automobile Industry

Bing Guo, Sarah Parlane and Lisa Ryan

Journal of the Association of Environmental and Resource Economists, 2026, vol. 13, issue 3, 649 - 680

Abstract: This study explores the path-dependent nature of cheating and investment in innovation as strategies for automobile manufacturers subject to environmental regulations. Firms first decide on their investments in innovation to develop compliant technologies. Then, knowing the outcome of innovation, they may opt to activate a cheating device. Successful innovation achieves compliance at reduced costs, while undetected cheating creates the appearance of compliance while eliminating all compliance costs. We show that higher investment in innovation discourages cheating. In contrast, the availability of cheating devices, used either systematically or as a fallback when innovation fails, leads to lower investment levels. We derive policy recommendations relying on comparative statics with respect to compliance costs, the likelihood of detecting cheating, the penalty imposed on cheating firms, and market competition.

Date: 2026
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