Overcompliance and voluntary agreements

Voluntary agreements with industry offer many examples of overcompliance wi th respect to environmental standards. Such phenomena seem to be irrational but appear less surprising considering firms' strategies are aimed to inte rnalise environmental quality. We model the choice of the environmental qua lity of products in a one-shot game between a monopolist and consumers, to show the existence of inefficient equilibria where quality is low because o f moral hazard. The firm can, however, change its' equilibrium strategy in a repeated but finite game, in order to build an environmental reputation i f we suppose that consumers' information is not only imperfect with regard to quality, but also incomplete with respect to any environmental constrain t that may affect the behaviour of firms (like the threat either of a stric ter regulation or of potential entry). In a two-period model, we show the e xistence of a perfect Bayesian equilibrium in mixed strategies where the fi rm can revert to the production of green products in order to influence con sumers' beliefs and acquire an environmentally friendly reputation. Due to the peculiarity of environmental information (green products are credence g oods), we claim that an explicit agreement is also necessary in order to es tablish monitoring and controlling procedures to verify the performance of firms. These procedures can explain per se the diffusion of voluntary agree ments that are nevertheless self-enforcing because of the reputation effect .