UC Berkeley

Firms have an incentive to test competitors' products to reveal violations of safety and environmental standards, in order to have competitors' products blocked from sale. This paper shows that testing by a regulator crowds out testing by competitors, and can reduce firms' efforts to comply with the product standard. Relying on competitor testing (i.e., having the regulator test only to verify evidence of violations provided by competitors) is most effective in large or concentrated markets in which firms have strong brands and high quality, and for standards that are highly valued by consumers. Under those conditions, firms tend to test competitors' products and exert high compliance effort. Conversely, unless compliance is highly valued by consumers, a firm with low quality does not draw testing from competitors, and so does not comply. Enforcing a product standard through competitor testing encourages entry by such low-quality, noncompliant firms and can reduce quality investment by incumbents. Stripping offending products of labels (such as "Energy Star"), instead of blocking them from the market, eliminates the problem of entry by low-quality, noncompliant firms, but may reduce incumbents' compliance efforts.