Much of what we understand about the advantages of emissions trading programs, particularly vis-à-vis traditional command and control approaches, is based on models of full compliance with these policies. However, emissions trading policies are not likely to perform as expected if these programs are not enforced well. Recognizing this concern, there is now a significant body of theoretical literature on the consequences of imperfect enforcement of emissions trading programs (e.g. Malik 1990, 1992; Keeler 1991; Stranlund and Dhanda 1999; Stranlund 2007). While the theory of the compliance and enforcement problem in emissions trading has advanced quite far, there are few empirical investigations of compliance behavior and the performance of emissions markets under imperfect compliance. The dearth of empirical research in this area is due to the fact that opportunities for empirical analyses of imperfect enforcement in existing trading programs are limited. In situations in which naturally occurring data are limited, laboratory experiments are particularly valuable. In fact, several recent papers use experiments to examine various aspects of imperfect compliance in emission trading programs (Cason and Gangadharan 2006; Murphy and Stranlund 2006, 2007). These works provide valuable results about the compliance behavior of subjects in experimental emissions permit markets, but none deal directly with the effects of noncompliance on the social costs and benefits of these programs. In this study, we use the data from a series of emissions trading experiments to examine the impacts of imperfect enforcement on industry welfare. By imperfect enforcement we mean that enforcement efforts – monitoring and penalties – are not sufficient to induce full compliance by all firms.
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