Compliance with environmental regulations is a major issue in most countries because imposing a limit on firms' emissions does not guarantee that effective emissions will meet the limit imposed. For the objective of the environmental policy agency to be accomplished, it is necessary that firms' behavior be monitored and the legal limits enforced. In addition, firms must be informed about the limits they are required to meet and must be able to comply with those limits.
Winter and May (2001) identified five sets of determinants for firms' decision to comply with environmental regulations: calculated motivations, normative motivations, social motivations, awareness of rules, and capacity to comply. The determinants depend on the firms, the community, and the public agency responsible for creating the regulations, monitoring firms' performance, and enforcing the regulations.
One precondition for firms' compliance with environmental regulations is their knowledge of the environmental regulations with which they must comply. Winter and May (2001) found that firms' awareness of environmental regulations plays a crucial role on their environmental compliance.
Social motivations for compliance may also be present. Specifically, public disclosure of information on the degree of compliance with the environmental standards by firms may put additional pressure on firms to comply with environmental regulations. Afsah et al. (2000) found that public disclosure of information in Indonesia has induced a decrease in polluting emissions, namely because it increases managers' information about their own plant's pollution and abatement opportunities. However, this effect is stronger if public disclosure programs are implemented in conjunction with external effects, such as effects on certification and on stock prices.
In sum, two issues related to information are essential for environmental compliance. On one hand, firms must be well informed about the environmental regulations with which they must comply, and, on the other hand, public disclosure of information about firms' environmental performance may raise their perceived social duty to comply. (1)
Firms' decision to comply with environmental regulation also depends on the behavior of the public agency that monitors and inspects firms' compliance. In other words, the decision to comply is also influenced by the enforcement and monitoring strategy of public agencies. These strategies influence the expected costs and benefits of compliance. (2) In particular, firms' expected costs and benefits of compliance are influenced by the likelihood of detection, the likelihood and amount of the fine, and the cost of compliance. Winter and May (2001) found that the higher the probability of detection, the higher the degree of compliance by firms; compliance is also greater if regulated firms think there is a stronger likelihood of a fine being imposed for a given violation.
With respect to the public agency's behavior, Dion et al. (1997) found that monitoring is not random. Using plant-level data from the pulp and paper industry in Quebec, Dion et al. (1997) found that larger firms and firms whose activity may cause higher environmental damages have a higher probability of being inspected. The latter result lends support to the theoretical work on monitoring issues, which in general predicts that monitoring activities occur more frequently at major sources of pollution and at firms where the public agency believes that environmental requirements are being violated. (3)
Empirical research into these issues is, however, relatively sparse mainly due to data limitations. The objective of this article is to analyze the environmental agencies' behavior with respect to the monitoring of environmental requirements and the firms' decision to comply with those requirements. Using data collected by a national survey of Portuguese firms in the pulp and paper industry, the authors first investigate the determinants of the environmental agency's decision to monitor and inspect polluting firms. …