# _Introduction_

The relationship between national regulation and international corporate behavior is characterized by a puzzling divergence between theoretical predictions and empirical findings. Concepts such as the Pollution Haven Hypothesis (in the case of environmental public goods) or regulatory arbitrage and subsequent regulatory race to the bottom are supported by mixed empirical evidence at best<sup>1</sup> . The literature has not provisioned any active role for demand and focused on regulation and its implied increase in production costs as the strategic dimension of interest to firms. This paper, however, suggests that the emergence of strategic, demand and market driven corporate provision of public goods<sup>2</sup> (often referred to as strategic Corporate Social Responsibility (CSR)) can play a crucial role in explaining why some firms might not follow the standard cost incentives to chase pollution or (labor standard) havens, thereby altering the framework for the use of environmental (social) regulation for purposes of international economic competition.

Observing that actual CSR often is inseparably linked to a firm's production process (e.g. "green" production technologies or labor standards along corporate supply chains) and therefore only imperfectly observable to outsiders, we find that absolute levels of information asymmetry between firm and market within a country as well as between country differences in such verifiability of CSR may jointly determine corporate incentives to (re)locate and ultimately a national authority's regulatory scope. CSR is analyzed as a consumption good characteristic with public and credence good character, and rational consumers with preferences for the respective public good expect CSR price premiums to be increasing in the degree of information asymmetry. Similar in spirit to Shapiro's (1983) incentive payment to induce quality maintenance or Leffler and Klein's (1981) protection money to induce contract performance, firms facing a higher incentive to cheat require higher compensation to induce contract performance, a circumstance that, combined with Bertrand competition, will determine equilibrium prices and CSR provision. Let's assume for the moment that firms face the choice to locate either in a developing country featuring lower production costs but high information asymmetry or in a developed country with higher production costs but low information asymmetry. Then, according to the outlined mechanism, a CSR firm<sup>3</sup> will trade off lower production costs, which increase its competitiveness in pricing, with higher expected informational price premiums, which decrease its competitiveness. The difference in the information environment will not only define location, but also the effective bandwidth (between CSR levels and relocation inducing levels of the public good) of non cooperative, national regulation. Then, while international convergence in transparency and information (e.g. through international labeling or standards) empowers markets, it simultaneously requires adaptation and increased coordination in environmental regulation and policy making.

The remainder of the paper is structured as follows. Section 1 will revisit the mismatch between theory and empirics of the trade, environment and regulation literature and

> 1 See Oates and Portney (2003) for a survey on Environmental Federalism (Section 5).

> 2 or reduction of public bads or externalities

> 3 being a firm that serves a consumer segment with respective environmental or social preferences

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