Firms’ Emissions and Self-Reporting Under Competitive Audit Mechanisms

Many environmental tax systems rely on self-reported emissions by firms. These emission reports are verified through costly auditing efforts by regulatory agencies that are constrained in their auditing budgets. A typical assumption in the literature is that the agencies allocate audit efforts randomly among otherwise identical firms (random audit mechanism). This paper compares the incentives on firms’ emissions and self-reporting behavior under the random audit mechanism to the incentives under competitive audit mechanisms (CAMs). Under CAMs, higher reported emissions by a firm relative to other firms result in a lower audit intensity. This creates a reporting contest between the firms. The two CAMs under investigation apply different degrees of competitiveness in the reporting contest. I find that both CAMs lead to more truthful reporting, which is in line with the previous literature. Interestingly and novel to the literature, I find that some competition in reporting may induce fewer emissions compared with random auditing, while too much competition in reporting may induce comparatively higher emissions caused by firms.