Third‐Party Inspection as an Alternative to Command and Control Regulation

This article makes the case for relying on decentralized market-based incentive mechanisms to supplement performance-based regulations for promoting industrial safety. In particular, we examine how third-party inspections, coupled with insurance protection, can encourage firms to reduce their risks from accidents and disasters. Our proposal is thus an example of a management-based regulatory strategy where the locus of decision making is shifted from the regulator to firms, which are now required to do their own planning as to how they will meet a set of standards or regulations. The third-party inspections we have in mind would take the form of a voluntary contractual relationship between the firm and the party auditing the facility in place of relying solely on the regulatory agency as enforcer. In undertaking the inspection, the third party can simply play the role of informing the firm that it is in violation of a regulation or, going one step further, it can assist the firm in developing a program for reducing its risks to comply with a particular standard or regulation. The passage of Section 112(r) of the Clean Air Act Amendments (CAAA) of 1990 offers an opportunity to implement such a program. This legislation created two new federal regulatory programs aimed at preventing releases of hazardous chemicals: the Occupational Health and Safety Administration (OSHA) Process Safety Management (PSM) standard and the U.S Environmental Protection Agency (EPA) Risk Management Program. The OSHA program was enacted in 1992 and requires facilities containing large quantities of highly hazardous chemicals to implement accident prevention and emergency response measures to protect workers. The EPA Risk Management Program regulation, published in 1996, borrowed the same accident prevention concepts and language from PSM but went beyond the OSHA program. It also required facilities to perform a hazard assessment, estimate consequences from accidents, and submit a summary report, called the Risk Management Plan (RMP), to EPA by June 21, 1999. The challenge is how to encourage compliance with these regulations so that firms will be operating in a safer manner. The article proceeds as follow. In the next section we make the case for well-enforced RMPs and then show in Section 3 why firms may not voluntarily comply with this regulation. Section 4 shows analytically that third-party inspections coupled with insurance provide economic incentives for many firms to undertake RMPs voluntarily and encourages the remaining recalcitrant firms to comply with the regulation. Section 5 illustrates implementation challenges in utilizing third-party inspections while at the same time pointing to their success in a variety of different contexts. The concluding section discusses a set of open issues and questions, the need for future studies, and what analysts and practitioners can learn from this work.