Environmental quality control and environmental games

This paper is concerned with the problem of an environmental "regulator" and a potentially "polluting firm" who uses a pollution technology, expressed by the propensity to pollute. Pollution risks, measured by their consequences are, however, a function of the regulators detection of polluting events. An event which is not detected is costless to the firm but costly to "society" faced with cleaning the environment while a detected polluting event induces a cost borne by both the firm and "society"-costs assumed shared in some fashion. Using a game theory framework we determine an endogenous pollution probability and an environmental control policy. Issues regarding investment in preventive measures, environmental controls and the likes are then assessed. The problems that both the polluting firm and the regulator are faced with are then two-fold: (1) given a polluting technology and a shared penalty cost when a polluting event occurs, what are the control effort to exercise by the firm and what controls and preventive efforts should the firm apply and (2) what are the effects of the technology choice and penalty-cost sharing parameters on the firm and society's payoffs. These problems lead to a random payoffs environmental game which we solve by assuming first risk neutrality and subsequently by assuming a quadratic (risk aversion) utility function for both the polluting firm and the environmental regulator.