This paper offers an option value-based rationale for the consideration of non-compliance record in punishment. We study compliance decisions of a population of individuals who live for two periods, where each individual's non-compliance benefits are random and independent over time. Because non-uniform sanction schemes produce different option values to current-period compliance and non-compliance, an optimal sanction scheme trades off present and future compliance and depends on the overall sanction and the distribution of non-compliance benefits. Escalating sanctions maximize compliance for a small overall sanction and a large mass of high non-compliance benefits.
- Graduated sanctions
- Option value