An Empirical Examination of Moral Hazard in the Vehicle Inspection Market

Moral hazard arises in "diagnosis-cure" markets such as auto repair and health care when sellers have an incentive to misrepresent a buyer's condition in order to increase demand for the treatments they supply. This article examines the market for California vehicle emission inspections. Using transaction-level data, I investigate whether the market provides incentives that lead inspectors to help vehicles pass and how the behavior of inspectors varies with their firm's organizational characteristics. I find that consumers are generally able to provide firms and inspectors incentives to help them pass, and I find cross-firm differences that are consistent with agency theory.