2.1. Abatement versus bribe

When a firm meets a corrupt official, it has a choice between paying the bribe and abating. A profit-maximizing firm chooses the alternative with the lowest costs. The cost of abatement is $c\cdot (\bar{e}-\underline{e})$ , and the bribe amounts to b. Therefore, the marginal firm that is indifferent about bribing or abating has a cost parameter of

(1) $$c_{AB} = {{b}\over{(\bar{e}-\underline{e})}}.$$

All firms with abatement costs c∈(0, c _AB ) will go for the abatement. The bribe is preferred by firms with costs $c\in (c_{AB},\hat{c})$ , where ĉ denotes the highest abatement costs among all firms that have entered the market.

2.2. Profit-maximizing bribe

Each corrupt official is assigned to a random sample of firms. Therefore, each corrupt official faces the same distribution of abatement costs as the entire population of firms in the market. We assume that firms cannot switch to another monitoring official. Thus, a corrupt official acts as a monopolist when setting the profit-maximizing bribe. We analyze the decision problem of a representative bureaucrat. The total bribe revenue amounts to

(2) $$B=b\cdot {{\hat{c}-c_{AB}}\over{\bar{c}}}.$$

$1/\bar{c}$ is the density of abatement costs, and $(\hat{c}-c_{AB})/\bar{c}$ is the proportion of firms willing to pay bribe b. Using (1) and taking the derivative of the bribe revenue with respect to b, we obtain the profit-maximizing bribe

(3) $$b^\ast ={{\hat{c}}\over{2}}(\bar{e}-\underline{e}).$$

Equations (1) and (3) imply that the marginal firm that is indifferent between abating and bribing has a cost parameter of $c_{AB}^{\ast} = {{\hat{c}}\over{2}}$ . Therefore, among all firms entering the market, exactly half will abate, and the other half of the same industry will not comply and will pay the bribe. This simple rule is due to our assumption of a uniform distribution. However, our main point is independent of this specific assumption and also holds for a general distribution of cost types: the endogenous choice of bribe payments will always allow some firms to circumvent the environmental regulation.

2.3. Market entry

Now we turn to the firms’ entry decision. Before entering the market, each firm knows that it will meet a corrupt bureaucrat with probability ρ, the proportion of dishonest officials. When meeting a corrupt official, a firm can choose between bribing and complying. It will choose whatever minimizes its cost. Therefore, the expected profit from market entry amounts to

(4) $$E\pi = P-K-\lsqb \rho \cdot \min \lsqb b^\ast,c\lpar \bar{e}-\underline{e}\rpar \rsqb + (1-\rho)c\lpar \bar{e}-\underline{e}\rpar \rsqb .$$

Solving for the marginal firm is slightly complicated by the fact that market entry depends on the bribe, and the bribe depends on marginal firm ĉ. According to the results from the previous section, marginal firm ĉ will always prefer to pay the bribe. In equilibrium, the marginal firm with cost ĉ anticipates future bribe b* and earns an expected profit of zero $[E\pi (\hat{c})=0]$ . Solving for ĉ yields

(5) $$\hat{c}^* = {{P-K}\over{\left(1 -{{\rho}\over{2}}\right)\lpar \bar{e}-\underline{e}\rpar }}.$$

If market entry pays off for the marginal firm with cost ĉ*, it will be profitable for the infra-marginal firms $c<\hat{c}^{\ast}$ a fortiori.Footnote ⁸ The equilibrium bribe amounts to $b^{\ast} ={{(P-K)}\over{(2-\rho)}}$ . All firms with abatement costs $c\in [0,\hat{c}^{\ast}]$ enter the market. When confronted with a corrupt official, those with costs $c\in \left[0,{{\hat{c}^{\ast}}\over{2}} \right]$ prefer to abate; all other firms $\left(c\in \left[{{\hat{c}^{\ast}}\over{2}},\hat{c}^{\ast}\right]\right)$ pay the bribe and pollute.

The comparative statics with regard to the share of corrupt officials lead to our first result.

Proof: Taking the derivatives with respect to the share of corrupt officials ρ immediately yields ${{\partial \hat{c}^*}\over{\partial\rho}} = {{2(P-K)}\over{(\bar{e}-\underline{e})(2-\rho)^{2}}} \gt 0, {{\partial c_{AB}^{\ast}}\over{\partial \rho}} \gt 0$ and ${{\partial b^{\ast}}\over{\partial\rho}} = {{(P-K)}\over{(2-\rho)^{2}}} \gt 0$ .   □

When the number of corrupt officials increases, this change facilitates the market entry of high-cost firms. As the chances increase that they can produce without any abatement by paying a bribe, market entry becomes more attractive. This market-entry effect is straightforward. The change in the bribe and the division into bribing and abating firms are less straightforward. The additional entry brings in firms that have high abatement costs and, therefore, have a high willingness to pay for circumventing the regulation. This makes it profitable for the corrupt official to increase the bribe slightly. Those firms that were previously indifferent between bribing and abating will now prefer to comply with the regulations. However, the additional bribe revenue from the firms with a high willingness to pay overcompensates the losses from those firms shifting to abatement.

Let us briefly note the effects of changes in the regulation on market entry because this idea will be an important channel in the subsequent analysis. The government determines the level of permissible emissions, e. An increase in e implies a more lenient environmental regulation. Taking the derivative of (5) with respect to e yields ${{\partial \hat{c}^{\ast}}\over{\partial\underline{e}}} = {{2(P-K)}\over{(\bar{e}-\underline{e})^{2} (2-\rho)}} \gt 0$ . Unsurprisingly, a more lenient regulation lowers the firms’ costs and leads to more market entry. Due to two countervailing effects, the bribe is not affected by changes in the regulation $\left({{\partial b^{\ast}}\over{\partial \underline{e}}}=0\right)$ . On the one hand, a more lenient regulation per se reduces the willingness to pay for circumventing the regulation (see equation (3)). On the other hand, however, the more lenient regulation also brings in additional firms with high abatement costs, which raises the bribe demand, ceteris paribus. As equations (3) and (5) show, these two effects offset one another. Hence, the lower costs also induce some firms to shift from bribing to abatement $\left({{\partial c_{AB}^{\ast} }\over{\partial \underline{e}}}>0 \right)$ .Footnote ⁹ Thus, a more lenient regulation leads not only to more (polluting) firms in the market but also to a shift towards cleaner production for some firms.

2.4. Environmental quality

Before turning to the welfare analysis, we will first discuss the effect of corruption on environmental quality. Put differently, we ask how a government that wants to achieve a certain environmental quality must adjust the environmental regulation when corruption increases.

First, we calculate the total emissions for a given environmental regulation. The emission level depends on the abatement cost. Firms whose costs are given by $c \in c(0,c_{AB}^{\ast})$ will comply with the governmental emission regulation and hence emit the permitted level of emissions, e. Share ρ of the firms with cost structure $c \in c(c_{AB}^{\ast},\hat{c}^{\ast})$ , however, will not comply, pay the bribe and emit an amount of $\bar{e}$ . Therefore, total emissions amount to

(6) $$E = {{1}\over{\bar{c}}}\cdot \left[c_{AB}^\ast \underline{e} + \rho \lpar \hat{c}^\ast - c_{AB}^\ast \rpar \bar{e} + \big(1-\rho\big)\lpar \hat{c}^\ast - c_{AB}^\ast\rpar \underline{e}\right].$$

Using (5), this can be simplified to

(7) $$E = {{1}\over{\bar{c}}}\cdot {{P-K}\over{1-{{\rho}\over{2}}}}\left[{{\underline{e}}\over{\bar{e}-\underline{e}}} +{{\rho }\over{2}}\right].$$

An increase in the share of corrupt officials leads to higher emissions $\left({{\partial E}\over{\partial \rho}}>0\right)$ for two reasons: first, a larger share of firms meets corrupt officials and can avoid any type of abatement; and secondly, the increase in corruption makes the entry of polluting firms more attractive at the margin $\left({{\partial \hat{c}^{\ast}}\over{\partial \rho}}\gt 0\right)$ .

A government that wants to keep total emissions, E, constant must react with tighter regulations when corruption increases. The total differentiation of (7) yields

(8) $$\left.{d \underline{e} \over d\rho}\right\vert_{E}= -{\bar{e}-\underline{e} \over 2-\rho} \lt 0.$$

Corruption allows some firms to circumvent the regulation. Without countermeasures, pollution will go up. The government can offset the effect by forcing the complying firms to abate more. We have introduced this intermediate step to contrast the environmentalist view with the welfare aspect. The optimal reaction of the government is not so obvious when we take welfare maximization as a government objective and allow for endogenous market entry.

2.5. Regulation and welfare

Here, we introduce the government's optimization problem. We focus on a benevolent government that wants to maximize social welfare. Welfare is defined as the sum of all profits generated by the firms minus the environmental damages from emissions $D\lpar E \rpar $ . It is not straightforward as to how a benevolent government takes into account bribe payments in its welfare considerations. If the government is only interested in total rents and does not care about the distribution of rents or the source of income, bribe payments will not show up in the welfare function. Here, bribes are simply a transfer from the non-complying firms to the corrupt officials. The government suffers from corruption because it affects entry and environmental damages but not from the illegal activity per se. However, the government may very well care about the distributional dimension. The income from bribes may be less valuable in terms of welfare than entrepreneurial income. To allow for both types of welfare functions, we subtract share δ of bribe income from welfare. For δ=0, the government shows no distributional concerns and is interested only in maximizing total rents. For δ=1, all illegally received income from corruption is lost in terms of welfare. Welfare (W) can be written as

(9) $$\eqalign{W &= \int_0^{c_{AB}^\ast} {{1}\over{\bar{c}}}\lpar P-K-c\lpar \bar{e}-\underline{e}\rpar \rpar dc \cr & \quad + \int_{c_{AB}^\ast}^{\hat{c}^\ast}{{1}\over{\bar{c}}}\lpar P-K-\big(1-\rho\big) c\big(\bar{e}-\underline{e}\big)\rpar dc - D(E) - \delta \cdot B,}$$

where B denotes the income from bribes.

$$B \equiv \rho\cdot b^\ast\cdot {{\hat{c}^\ast}\over{2{\cdot}\bar{c}}} = {{\rho{\cdot}(P-K)^2}\over{4{\cdot}\bar{c}{\cdot}\left(1 - {{\rho }\over{2}}\right)^2 \cdot \lpar \bar{e}-\underline{e}\rpar }}.$$

Note that the income from bribes decreases with tightness of regulation $\lpar \bar{e}-\underline{e}\rpar $ and increases with the share of corrupt officials ρ. We can rewrite the welfare in (9) as

(10) $$\eqalign{W &= {{1}\over{\bar{c}}}\left\{(P-K)\hat{c}^\ast - {{\hat{c}^{\ast 2}}\over{2}}\lpar \bar{e}-\underline{e}\rpar \left[1-{{3\rho}\over{4}}\right]\right\}\cr & \quad - D\left({{\hat{c}^\ast}\over{\bar{c}}}\cdot \left\{\underline{e}+ {{\rho }\over{2}}\lpar \bar{e}-\underline{e}\rpar \right\}\right) - \delta \cdot \rho \cdot {{\hat{c}^{\ast2}}\over{4{\cdot}\bar{c}}}\cdot \lpar \bar{e}-\underline{e}\rpar }$$

where P−K is the output per firm; the second term captures the abatement costs, the third term describes the environmental damages, and the fourth term measures the welfare costs when income flows to corrupt officials. For didactic purposes, we first analyze the case with fixed market entry, i.e., with a given ĉ*, before we turn to the case of endogenous market entry.

2.5.1. Fixed market entry

Suppose that the government decides on the restrictiveness of the regulation when market-entry decisions have already been made. All firms with abatement costs $c\le \hat{c}^{\ast}$ have entered the market. Taking the derivative with respect to the permissible emission level e yields

(11) $$\left.{{\partial W}\over{\partial \underline{e}}}\right\vert_{\hat{c}^\ast} = {{1}\over{\bar{c}}}{{\hat{c}^{\ast 2}}\over{2}}\left[1 - {{3\rho}\over{4}}\right] - D'(E)\cdot {{\hat{c}^\ast}\over{\bar{c}}}\cdot \left(1-{{\rho}\over{2}}\right) + \delta\cdot \rho\cdot {{\hat{c}^{\ast 2}}\over{4{\cdot}\bar{c}}} = 0$$

When distributional issues are irrelevant for welfare (δ=0), the welfare-maximizing regulation $\underline{e}^{\ast}$ is characterized by equalizing marginal abatement costs and marginal environmental damages. If redistribution towards corrupt officials is considered as detrimental to welfare (δ>0), a slight easing of environmental regulation has the additional benefit of reducing bribe incomes; this effect is captured by the third term in (11). We are now interested in how optimal regulation changes when corruption increases:

(12) $$\left.{{d\underline{e}^\ast}\over{d\rho}}\right\vert_{\hat{c}^\ast} \matrix{ > \cr < }0 \Leftrightarrow {\partial \left(\left.{{\partial W}\over{\partial \underline{e}}}\right \vert_{\hat{c}^\ast}\right)\over {\partial \rho}} \matrix{ > \cr < }0.$$

Taking the derivative of (11) with respect to ρ and replacing D′(E) with the first-order condition yields

(13) $${\partial \left(\left.{{\partial W}\over{\partial \underline{e}}}\right \vert_{\hat{c}^\ast}\right)\over {\partial \rho}}= - {{\hat{c}^{\ast2}\over{4}}}{{1-2\delta}\over{2-\rho}}-D''{{\hat{c}^{\ast 2}\over{2\bar{c}}}} \lpar \bar{e}-\underline{e}\rpar \left(1-{{\rho }\over{2}}\right).$$

If distributional concerns are not too strong (δ<1/2), the government will tighten the regulations when corruption increases, i.e., expression (13) is negative.Footnote ¹⁰ The logic is straightforward. If the share of corrupt officials increases, more firms can circumvent environmental regulations. For a given number of firms, pollution increases. Therefore, the increase in the marginal environmental damage makes it optimal for the government to choose a lower permissible emission level. Firms adhering to environmental regulations pay the price of increased corruption.

2.5.2. Endogenous market entry

In the next step, we consider that the environmental regulations also affect the number of firms entering the market. If the government chooses a more lenient environmental regulation, more firms will enter the market $\left({\partial\hat{c}^{\ast}\over{\partial \underline{e}}} > 0\right)$ . The welfare-maximizing environmental regulation is now implicitly given by

(14) $$\eqalign{{{\partial W}\over{\partial \underline{e}}} &= {{1}\over{\bar{c}}}\cdot \left\{(P-K)-\hat{c}^\ast \cdot \lpar \bar{e}-\underline{e}\rpar \cdot \left(1-{{3}\over{4}}\rho \right) - D'(E)\cdot \left(\underline{e}+{{\rho }\over{2}}\lpar \bar{e}-\underline{e}\rpar \right)\right.\cr & \quad \left. \left. -\delta \cdot \rho \cdot {{\hat{c}^\ast}\over{2}}\cdot \lpar \bar{e}-\underline{e}\rpar \right\} \cdot {{\partial\hat{c}^\ast}\over{\partial \underline{e}}} + {{\partial W}\over{\partial \underline{e}}}\right\vert_{\hat{c}^\ast} = 0.}$$

To understand how the market-entry effect changes the environmental policy, we analyze the marginal welfare change at the permissible pollution, $\underline{e}^{\ast}$ , that was optimal for a given market entry for firms (see equation (11)), as $\left.{{\partial W}\over{\partial \underline{e}}}\right\vert_{\hat{c}^{\ast}}=0$ by definition. Because the welfare function (10) is concave in e at the optimum, the sign of the term in curly brackets indicates whether the entry effect leads to a tougher or more lenient regulatory policy. If the term in brackets is positive, then a small increase in e will improve welfare. Substituting D′(E) from the first-order condition (11) and using $\hat{c}^{\ast} = {{P-K}\over{\left(1-{{\rho }\over{2}}\right)\lpar \bar{e}-\underline{e}\rpar }}$ yields (after some simplifications):

(15) $$\eqalign{{{\partial W}\over{\partial \underline{e}}}\lpar \underline{e}^\ast\rpar &= {{1}\over{\bar{c}}}\cdot {{P-K}\over 2{\cdot}\left(1-{{\rho }\over{2}}\right)}\left\{ 1-{{\rho}\over{4}}-{{\bar{e}}\over{\bar{e}-\underline{e}}}\cdot {{1-{{3}\over{4}}\rho}\over{1-{{\rho}\over{2}}}} \right. \cr & \quad \left. - \delta \cdot {{\rho }\over{2}}\cdot \left(1+{{\bar{e}}\over{\bar{e}-\underline{e}}}\cdot {{1}\over {1-{{\rho}\over{2}}}}\right)\right\}\cdot {{\partial \hat{c}^\ast}\over{\partial \underline{e}}}.}$$

In a world without corruption (ρ=0), we can clearly sign the entry effect.

Proposition 2

Without corruption, market entry makes a tighter environmental regulation optimal (compared to the case without market entry).

Proof For ρ=0, equation (15) simplifies to ${{\partial W}\over{\partial \underline{e}}}\lpar \underline{e}^{\ast}\rpar = {{1}\over{\bar{c}}}\cdot {{P-K}\over{2}}\left\{-{{\underline{e}}\over{\bar{e}-\underline{e}}}\right\}\cdot {{\partial \hat{c}^{\ast}}\over{\partial \underline{e}}}$ . Because the term in curly brackets is negative and ${{\partial \hat{c}^{\ast}}\over{\partial\underline{e}}}>0$ , we obtain ${{\partial W}\over{\partial \underline{e}}}(\underline{e}^{\ast})<0$ . At the optimal environmental regulation without entry ( $\underline{e}^{\ast})$ , the marginal effect on welfare is negative. Therefore, having a tighter regulation is optimal when market entry becomes endogenous.   □

The following logic applies for this result: when the government tightens regulations (i.e., lowers e), the marginal firm will leave the market without having to pay the higher abatement costs. However, without the exit option, the marginal firm must bear the higher cost. Thus, from the government's perspective, the marginal social cost of abatement is lower when non-profitable firms can exit. This effect makes it optimal for the government to choose a tighter regulation in case of endogenous entry. A similar result has been found in oligopolistic markets. Katsoulacos and Xepapadeas (Reference Katsoulacos and Xepapadeas1995) show that the optimal tax can exceed the marginal environmental damage when market structure is endogenous. Compared to the case with a fixed number of firms, environmental policy is stricter with endogenous market entry.Footnote ¹¹

How does corruption influence this entry effect? We analyze the welfare effect of a marginal increase of e for ρ>0. Our reference point is still the optimal regulation $\underline{e}^{\ast}$ that would have been chosen with exogenous market entry.

Proposition 3

With corruption, market entry has an ambiguous effect on optimal environmental regulation (compared to the case of without market entry). For high levels of corruption, market entry can force the government to choose an even more lenient environmental policy if distributional issues are a minor concern. Distributional considerations make the tightening of environmental policy more likely.

Proof: The inspection of equation (15) immediately indicates that the curly bracket cannot be signed unambiguously. For ρ→0, the term in curly brackets in (15) is negative; the entry effect leads to a tighter regulation. With (a) no distributional concerns (δ = 0), the term in curly brackets is increasing in $\rho:{{\partial}\over{\partial \rho}} = {{1}\over{4}}\cdot \left({{\bar{e}}\over{\bar{e}-\underline{e}}}\cdot {{1}\over{\left(1-{{\rho}\over{2}}\right)^{2}}}-1\right) > 0$ . Therefore, the term may become positive for a sufficiently large ρ; the entry effect can lead to a more lenient regulation when corruption is widespread. (b) Distributional concerns (δ>0) have a countervailing effect: ${{\partial}\over{\partial \rho}} = {{1}\over{4}}\cdot \left({\bar{e}\over \lpar \bar{e}-\underline{e}\rpar } \cdot {1 \over \left(1-{\rho \over 2 }\right)^{2}}- 1 \right) - {\delta \over{2}}\cdot \left({\bar{e}\over \lpar \bar{e}-\underline{e}\rpar } \cdot {1 \over \left(1-{\rho \over 2 }\right)^{2}}+ 1 \right)$ Strong distributional concerns make it more likely that the government will tighten the environmental regulation.

For a better understanding of the mechanism at work, we focus on the case δ=0: corruption facilitates the market entry of polluting firms, thus making a tighter regulation worthwhile. Conversely, an increasing share of corrupt officials also drives up the bribe rate (see proposition 1), which leads to an increasing divergence between the expected private and social costs of market entry. Bribes are private costs, but for δ=0, they are pure transfers from non-abating firms to corrupt officials from a social perspective. With an environmental regulation that equates marginal abatement costs and marginal environmental damages for a given number of firms (see equation (11)), entry may be too low from a social perspective. Therefore, the government may prefer a more lenient policy.

Proposition 3 demonstrates that the tradeoff for a welfare-maximizing government may change when corruption is a factor. From an environmental perspective, an increase in corruption should always lead to a tighter environmental regulation. The situation may be different from a welfare perspective. Protecting the environment becomes costlier due to corruption. Corruption drives a wedge between the private and the social benefits of market entry. Thus, when corruption increases, it becomes optimal for the government to exchange some environmental protection for a marginally higher market entry.Footnote ¹² This result can be achieved by relaxing the regulatory requirements.

This mechanism may also help explain why many developing countries seem to focus more on growth and market entry rather than on environmental protection.Footnote ¹³ From the perspective of a corruption-free society, this policy choice might seem suboptimal. However, in a society where corruption is prevalent, a welfare-maximizing government might find it worthwhile to relinquish the rather futile efforts of environmental protection and focus instead on expanding productive (but environmentally destructive) activities.

3.1. Alternative scenario I: entry before choice of regulation

Suppose that the government decides on the tightness of environmental regulation after firms have made their entry decision. This alternative sequence of moves may reflect the long-term nature of market entry and the ability of the government to react to this market entry. The alternative sequence of moves is depicted in figure 2.

Figure 2.

Sequence of moves in Alternative scenario I

Because the last two stages are identical to our baseline model, the outcomes must also be the same. The critical cost where a firm is indifferent between abatement and bribe is given by (1), and the profit-maximizing bribe is described by (3). In stage 2, the government maximizes welfare (9), where environmental quality is defined in (6). The only difference is that entry ĉ* is given for the government and is no longer a function of environmental regulation. Taking the derivative of (9) with regard to environmental regulation e yields, after some simplifications,

(11') $${\partial W \over \partial \underline{e}} = {{1}\over{\bar{c}}} {{\hat{c}^{\ast 2}}\over{2}} \left[1 - {{3\rho}\over{4}}\right] - D'(E)\cdot {{\hat{c}^\ast}\over{\bar{c}}} \cdot \left(1-{\rho \over{2}}\right) + \delta \cdot \rho \cdot {\hat{c}^\ast\over{4{\cdot}\bar{c}}} = 0.$$

Comparison of (11) and (11^′ ) shows that the government chooses the same level of environmental regulation whether the firms decide on entry before or after regulation. Hence, what matters for our key results is that firms have a choice of entry but not the timing of choices. This neutrality result is clearly due to the atomistic firms and the uniform distribution of costs. Things would be different if firms could behave strategically, e.g., by investing at different levels.

3.2. Alternative scenario II: abatement decision before inspection

What happens when the firms have to make their abatement decision before any inspection takes place? In the baseline model, firms operated with abatement when monitored by an honest official and circumvented the regulation when cooperating with a corrupt official. Therefore, firms could adjust their abatement according to the orders of the supervisory agency. An alternative view is that firms make an abatement choice before any inspection takes place. This could be particularly relevant when firms make long-term technology choices when entering a market. Therefore, we assume in the following time sequence (see figure 3) that firms simultaneously decide on entry and abatement before the administration inspects the production site. A corrupt official who inspects a non-compliant firm will ask for a bribe. Non-compliant firms that are not willing to pay the bribe or that are monitored by honest officials are closed down; i.e., firms exit the market again.

Figure 3.

Sequence of moves in Alternative scenario II

We briefly sketch the solution of this game. As the government's degree of control is crucial here, we assume that only a fraction γ of firms is monitored at all.Footnote ¹⁴ In stage 4, all non-compliant firms that are monitored by corrupt officials compare bribe b with benefit P of staying in the market. Hence, corrupt officials will extract all rents from these firms by charging b=P in stage 3. In stage 2, each firm has three options: stay out of the market, or enter with abatement (e) or without abatement ( $\bar{e}$ ). Entering with compliant abatement yields a profit of $E\pi_{A} =P-c\cdot \lpar \bar{e}-\underline{e}\rpar -K$ ; the firm earns a revenue of P but has to shoulder abatement and entry costs. Because the firm violates no regulations, neither the probability of inspection nor the share of corrupt officials matters for the determination of profits. For firms that do not comply, the expected profit amounts to $E\pi_{0} =(1-\gamma)\cdot P+\gamma \cdot [\rho \cdot 0+(1-\rho)\cdot 0]-K=(1-\gamma)\cdot P-K$ . With probability (1−γ), firms are not inspected at all and earn P. Net earnings become zero. If the official is honest, the firm is forced to close down; if the official is corrupt, the entire revenue is transferred via bribe payments to the corrupt official. To focus on the interesting case, we assume that $(1-\gamma)\cdot P-K>0$ ; i.e., the monitoring rate is sufficiently low that firms consider entering without sufficient abatement.Footnote ¹⁵ Comparison of Eπ _A and Eπ₀ immediately shows that all firms with abatement costs $c\le {{\gamma \cdot P}\over{(\bar{e}-\underline{e})}}$ prefer entering with a compliant strategy; all other firms take the risk of being detected and of having to exit the market. Obviously, corruption has no effect on entry in this scenario because corrupt and honest officials generate the same net revenue for detected firms. Of course, corruption is not neutral with regard to the distribution of rents or the level of total emissions. Whereas honest officials force non-compliant firms to exit the market, corrupt officials allow firms to continue production with high emissions.Footnote ¹⁶ If firms have to decide on abatement before being monitored, there is no feedback effect of corruption on market entry. Hence, the tradeoff between environmental quality and entry vanishes in this case.