This article analyzes the law and economics of market internalization: the capability of markets to both penalize and reward firms for their environmental, health and safety performance. As for market sticks, the article maintains that market transactions - both private and public sales of corporate assets as well as transactions in publicly traded securities - are an important avenue through which firms realize comparative advantages in regulatory compliance, and that such transactions have the potential to significantly enhance corporate environmental and social performance. Asset transactions tend to drive environmental cleanup and transfer assets to firms that are better able to know about and comply with relevant regulatory directives. On public securities markets, the very fact that traders are imperfectly informed about firm-specific regulatory risk causes disproportionately large market reaction to the revelation of such risks. The incentive to avoid such large, negative market reactions to the revelation of negative information leads may induce a higher level of compliance than were no such market reaction anticipated. Incentives for voluntary disclosure of negative information are complex, but as is true of financial disclosure, mandatory disclosure requirements may be crucial in allowing firms to make such credible commitments. As for the potential positive rewards (in the form of price premia) that SR consumers and investor offer to firms that they perceive to be pursuing CSR, the fundamental problem is that CSR cannot be directly observed by consumers and investors. Unless firms can find a credible signal of CSR, the positive potential of the market may go unrealized. Inevitably, much corporate communication regarding CSR is (from a game-theoretic point of view) cheap talk. There is likely to an uninformative, pooling equilibrium in which only firms in industries with well-recognized, large SR impacts are likely to engage in CSR cheap talk, so that such reports do not generate information on the relative economic and social performance of firms within the category of firms that report.

Jason S. Johnston, Signaling Social Responsibility: On the Law and Economics of Market Incentives for Corporate Environmental Performance, 05-16 U. of Penn Inst. for Law & Econ. Research Paper (2005).