Disclosure policy design and regulatory agent behavior

Abstract Mandatory disclosure promotes self‐regulation of product quality but may also provide incentives for firms to manipulate disclosed information. Collection of quality information by inspectors protects against direct manipulation, but firms may attempt to unduly influence inspectors. In Las Vegas, Nevada, food‐service health inspections are numerically scored, with health code violations from three categories carrying prescribed demerit amounts. For disclosure however, numeric scores are coarsened into letter grades, which may encourage lobbying of inspectors to under‐report violations near threshold scores. Beginning in 2013, the demerit amount prescribed for each good‐practices violation was reduced from 1 to 0; whereas the letter‐grade scale and penalties prescribed for major and critical violations (3 and 5 demerits each) remained unchanged. Exploiting this removal of scoring implications from good‐practices violations, coupled with the discontinuous punishment severity inherent in letter‐grade disclosure, I find that inspectors significantly under‐reported good‐practices violations prior to 2013—by 31%–90% in some cases—when those violations were likely to affect letter grades. Without careful design, disclosure policies supplementing inspection programs may inadvertently undermine the regulatory efforts they were meant to support.