Fly-By-Night Firms, Credit, and Regulation: A Simple Model

Abstract

“Fly-by-night” is a derisive term for a firm that appears to be untrustworthy and/or transient. Previous studies have focused on general fly-by-night firms’ behavior and their interaction with the credit market, while much less has been done to show how they approach government regulation. After a brief explanation of the importance of studying fly-by-night firms and a discussion of some relevant literature, this paper presents a simple model that permits a liability-holding fly-by-night entrepreneur to choose between complying or not complying with a governmental regulation. Though perhaps most useful as a classroom exercise, the model could be used to examine what factors affect the compliance decision and in what way. I find that (i) if we assume fly-by-night firms have relatively lower probabilities of project success, then they are unambiguously less likely to comply with governmental regulations; (ii) an increase in the interest rate on business loans decreases the probability of compliance; and (iii) from a regulatory
standpoint, an increase in inspection rates deters non-compliance, but an increase in the noncompliance fine may not exert deterrence if strategic default is an option.