In this paper, we model a differential game played `a la Stackelberg between a regulator
and a polluting firm in a stock pollution context. The regulator can be a single
body deciding on the emission standard and the probability of inspection overtime
as functions of the pollution stock. Alternatively, the regulator can delegate the inspection
activities to a local agency that maximizes revenues coming from fines net
of inspection costs. Although the objective of the agency departs from social welfare,
decentralization can be welfare improving, crucially depending on the type of strategic
interaction between the local agency and the polluting firm, as well as on the firm
anticipating the effects of current pollution decisions on future regulatory policy. Up
to our kowledge, this is the first paper dealing with hierarchical regulation in a stock
pollution context.
