Why Firms Compete for Regulation

Why should we expect companies to engage in regulation and thereby perform governance functions? Unlike states and civil society actors, firms are not committed to the public good but pursue private interests. We argue that under certain conditions private for-profit actors are inclined to actively engage in the fostering of regulation. The governance literature posits that the shadow of hierarchy cast by the state is a key incentive in this respect. In order to avoid state regulation, firms may choose voluntarily to commit themselves to reaching a regulatory outcome closer to their preferences. Moreover, the possibility of state intervention reduces the incentive to renege on a voluntary commitment (cf. Mayntz and Scharpf 1995; Scharpf 1997; Heritier and Lehmkuhl 2008).

Yet, if the shadow of hierarchy is a key premise for the regulatory engagement of firms, this results in a dilemma, if not a paradox, for regulators in areas of limited statehood. Failed and failing states are not only too weak to credibly threaten companies with regulatory intervention; often they do not even provide sufficient stability to allow for collective self-organization of market actors. Nevertheless, we do find corporate regulatory engagement in areas of limited statehood. Multinational companies police local communities, voluntarily implement environmental protection standards, provide HIV/AIDS-related services, or agree to use sustainable energy (Deitel- hoff and Wolf 2010; Flohr et al. 2010). In some instances, they even seek to foster state regulation by pressuring for stricter legislation and helping to strengthen the enforcement capacity of state actors (Vogel and Kagan 2004; Flanagan 2006; Mol 2001). How can we explain these findings?

Strategic choice and bargaining approaches allow us to derive a series of hypotheses on when firms are likely to engage in strict self-regulation or press governments to issue public regulation in states, which are too weak to credibly enact or enforce legislation. These approaches assume that competing firms that operate in the same reference market prefer no regulation over weak regulation over strict regulation.4 However, under certain conditions, the situational preferences of firms favor strict self-regulation if the imposed regulatory standards enhance the market value of the product offered. Under these circumstances firms have an incentive to increase the strictness of their self-regulation to augment the product quality and increase their prospects of successfully marketing this product (Ammenberg and Hjelm 2003; Anton et al. 2004; Parker 2002). By engaging in product competition with other firms targeting the same market, firms may trigger off a regulatory race to the top: once a firm starts engaging in self-regulation, increasing the quality of its products, competitors will have strong incentives to follow suit for fear of losing market shares.5

Firms interact in the context of specific environmental conditions, which pose additional demands to be taken into account when calculating the costs and benefits of their regulatory choices (Brousseau and Fares 2000; Wolf, Deitelhoff, and Engert 2007, 299-300). In our case, the relevant environmental conditions that we consider of particular importance are (1) the existence or absence of NGO campaigns affecting firms’ attitudes toward an increase in regulatory stringency, and (2) the existence of strict public regulation in the country of origin of a firm.

Conducting a systematic variation of either environmental conditions or actors’ preferences, we predict particular outcomes as regards firms engaging in self-regulation or pressing for public regulation. We argue that the causal mechanism linking environmental conditions to outcomes is a process of economic incentives and implicit bargaining among the concerned actors. Actors instrumentally learn from competing actors and thereby increase their benefit. If they do not instrumentally learn from their competitors, they lose out in markets. It reflects a bargaining situation in which the choice of actors will determine the allocation of some values, and in that the outcome of each participant is a function of the behavior of the other actors (Young 1975, 3).

A distributive power-based bargaining approach allows us to conceptualize the second underlying causal mechanism linking the explanatory factors to the outcomes. The relevant actors engage in an implicit bargaining process (Sebenius 1992), in which, depending on their relative power, they are able to influence the distribution of the surplus of the bargaining process in their favor. The relative power of the involved actors derives from their time horizon, the institutional rules governing the bargaining process-such as the sequence of actions and the preexisting regulatory provisions-as well as actors’ resources (Faure and Rubin 1993).

Given these assumptions and the underlying bargaining models, we employ a strategic choice approach. We begin by varying actors’ preferences— that is, the preferences of firms—and holding environmental conditions constant.

The first important factor that may prompt a willingness to engage in a regulatory race to the top is a firm’s brand name and high-market orientation. If a firm blatantly neglected regulatory standards to protect the environment and public health in its productive activities, it would lose business and the marketing prospects of its products would deteriorate as compared to other firms observing these standards (Haufler 2001b; Mol 2001, 97-100; Blanton and Blanton 2007). Moreover, obvious violations of social or environmental standards may result in public shaming and consumer boycotting. Thus, reputational incentives may account for firms’ strict self-regulation or pressing governments to issue strict regulatory standards.

1. Brand-name firms targeting the same high-end market are more likely— ceteris paribus—to engage in a regulatory race to the top than non-brand-name firms not targeting a high-end market (“brand-name/high-end market hypothesis”).

We further assume the existence of an incumbent firm with high regulatory standards that is faced with a foreign competitor with low regulatory standards targeting the domestic market. In this situation, the established firm will seek to press its government to issue strict regulation binding for both the established firm and new market entrants. By imposing strict regulation upon foreign competitors, the home firm will improve its commercial position in the home market, maintain its competitive advantage, and even manage to force out its opponents (Rugman, Soloway, and Kirton 1999; Garcia-Johnson 2000; Porter and van der Linde 1995; Kolk, van Tulder, and Welters 1999). To successfully negotiate such measures, the established firm has to be able to credibly threaten its government, for example, by menacing to leave (cf. Honke et al. 2008).

2. If an established firm is faced with a strong foreign competitor adhering to low regulatory standards, it will—ceteris paribus—press its government for stricter regulation of goods targeting the home market (“keeping-competitors- out hypothesis”).

We systematically vary political environmental conditions while holding firms’ preferences (competing firms that operate in the same reference market prefer no regulation over weak regulation over strict regulation) constant. Our first environmental factor of interest is the existence or nonexistence of an NGO campaign that puts firms under pressure to engage in self-regulation. The reputation of a company and the loyalty of its clients constitute a key corporate asset (Spar and LaMure 2003). Firms that are targeted by NGO campaigns that condemn their process of production and product quality risk reputational costs, consumer boycotts, loss of market shares, falling stock prices, and criticism by their shareholders (Waygood 2006; Hendry 2006; Wheeler 2001). Thus, they will seek to meet this criticism by adopting self-regulatory standards that alleviate the negative external effects of their mode of production (Schepers 2006; Trullen and Stevenson 2006; Hoffmann 2001; Halfteck 2008).

3. If firms are subject to strong NGO campaigns, they are—ceteris paribus— more likely to engage in strict self-regulation (“NGO campaign hypothesis”)

The strictness of regulation in a firm’s country of origin may be crucial in accounting for its willingness to subject itself to strict self-regulation. International firms tend to transport their regulatory standards abroad if investing in foreign countries (Murphy 2000; Skjaerseth and Skodvin 2003; Hall and Soskice 2001; Xing and Kolstad 2002). If these regulatory standards—often a result of complying with national regulatory requirements—are applied in foreign countries, these firms will contribute to an increase in regulatory standards in the country of investment.

4. A firm that originates in a country with strict regulation is more likely to seek strict regulatory standards in the foreign country of investment and, therefore, exert pressure for higher regulatory standards (“home country regulation hypothesis”).

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