Delegation and the Regulation of Risk

By Hugo HopenhaynIngrid Werner
1992| Working Paper No. 1212

It has been argued that U.S. regulatory agencies take an extreme and often inconsistent approach to the regulation of risk: they tend to overreact to dramatic, well-publicized accidents and disasters. The standard explanation invokes the existence of a cognitive bias: individuals tend to overestimate the frequency of low probability events and underestimate the frequency of high probability events._x000B__x000B_This paper explores an alternative hypothesis that does not rely on bounded rationality as an explanation. We examine whether the over-and underregulation of hazardous activities might be due to some particular features of the political oversight of regulatory agencies. Their political principal typically intervenes in response to external signals about the risks associated wtih hazardous activities. Our analysis suggests that regulatory decisionmaking may be biased in the presence of asymmetric or coarse information flows. In particular, it implies that low probability hazards will tend to be overregulated, high probability hazards underregulated.