Evaluating an adverse selection model of pollution control, using French individual data.

Summary This paper studies the effects of discharge standards, taxes and contractual regulation on the decision of an industrialist to invest in a wastewater treatment plant. The authors develop an adverse selection model with moral hazard, to analyze the strategy of a water agency confronted with an industrialist in the negotiation process. This model allows for both over- and under-investment results. The model is estimated on individual data by a simulated pseudo maximum likelihood (PML) procedure. The empirical results show that the moral hazard effect dominates the adverse selection effect, therefore the investment in purification tends to be oversized.