Quality Leadership when Regulatory Standards are Forthcoming

In many markets, governments set minimum quality standards while some sellers compete on the basis of quality by exceeding them. Such quality leadership strategies often win public acclaim, especially when they involve environmental attributes. Using a duopoly model of vertical product differentiation, we show that if the high‐quality firm can commit to a quality level before regulations are promulgated, it induces the regulator to weaken standards, and welfare falls. Our results raise doubts about the social benefits of corporate self‐regulation, and highlight the dangers of lengthy delays between legislative mandates for new regulations and their implementation.