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Treading the Regulatory Waters

With government so involved in business, business cannot afford to sit on the sidelines. A recent Mercatus Center at George Mason University study explores the relationship between business political activity (lobbying and campaign expenditures) and business success, and finds that with few exceptions, lobbying isn't correlated with better business performance. The paper's findings must be viewed in light of an important factor driving companies' involvement in policy debates: the need to fend off distortive, ineffective, and costly regulations. This type of lobbying is not likely to generate profits.

The study's authors appropriately acknowledge that not all lobbying is the same. Sometimes companies lobby for government goodies in the form of subsidies, guarantees, government contracts, regulatory barriers to competitors' entry, and regulatory obstacles to their success. This is cronyism. And it has the potential to pervert free markets by making satisfying customers less important than satisfying regulators.

But there is a second category of political activity: defensive lobbying. Often companies lobby to keep themselves out of the government's expansive regulatory eye rather than to become the apple of the government's eye and recipient of its favors. They lobby to stave off regulation that could prevent competitive markets from working as they should, and they lobby to identify unintended consequences that legislators or regulators--without direct business experience--might have difficulty spotting on their own.

The study's authors note the distinction between cronyism and defensive lobbying, but for analytical ease label all political and lobbying activity "cronyism." As the authors explain in a footnote, "a limitation of this study is that we cannot separate out results that may indicate defensive lobbying." This limitation is critical to any interpretation of the study's findings.

Lobbying for favored status is hard to disentangle from purely defensive lobbying. Government money and privileges often come with costly regulatory strings, which makes the disentangling even more difficult. On the other hand, even something that superficially appears to be a government favor may not always be. Consider the Troubled Asset Relief Program (TARP), which clearly benefited some of the banks to which it provided capital. But other banks lobbied to be allowed not to take the money. As former House Financial Services Committee Chairman Barney Frank explained in recent testimony, Treasury "Secretary [Henry] Paulson essentially had to compel several of the largest banks to accept TARP money even though some did not need it or want it, lest the institutions that did require help be stigmatized."

More generally, developments in the financial industry over recent years illustrate just how difficult it is to ascertain companies' objectives in the political and regulatory sphere. In 2007 through 2009, when the financial crisis was in full swing, some companies did come to the government looking for handouts, such as underpriced loans, guarantees, purchase subsidies, and restrictions on short selling.

But in the subsequent years, during the formulation and implementation of the legislative response to the crisis, much (but not all) of the political and regulatory activity has been an attempt to prevent legislators and regulators from destroying, distorting, or disabling effectively functioning markets--markets that serve businesses and families.

Given how central regulation has become in so many industries, financial firms and other heavily regulated companies would do themselves tremendous harm by staying out of the regulatory debates. Participation in policy discussions, as necessary as it often is to a firm's well-being, is unlikely to be reflected in contemporaneous profitability measures for the firms and industries involved. Defensive lobbying activity is merely treading water to avoid drowning in a sea of new regulations. If firms did not take part in the policymaking process, over time shareholders would see regulatory burdens rise and the value of their investment fall. This is a sad state of affairs, to be sure -- but it is the reality.

Accordingly, it is not surprising that the benefits generated by defensive lobbying do not manifest themselves in the study's financial performance measures. The study finds "no positive correlation between industry-level performance measures and political activity" and "no evidence ... that firm financial performance is enhanced by political connections as measured by firm lobbying activity." (The financial industry is the only one for which the study finds that political activity slightly positively affects firm performance.) Instead, the study finds a positive link between political activity and executive compensation. These findings might lead one to conclude that political activity pays off, but only for corporate executives.

Taking account of the defensive nature of much lobbying changes things. Executives may simply demand more compensation as the time and attention spent dealing with regulatory headaches grows and as the requisite talents for the job expand beyond merely running a business to navigating regulations.

Regulatory changes can be very costly for firms, which helps explain why they frequently lobby against new, burdensome regulations. This kind of lobbying isn't intended to grow a firm's bottom line, but rather to prevent its erosion. This is akin to having to divert money from revenue-generating activities to fend off meritless lawsuits. Much as they would prefer to focus on producing goods and services, companies effectively have little choice but to be engaged in shaping regulatory policy that will affect their ability to produce those goods and services.

The sad reality is that policymakers and regulators have made it effectively impossible for firms to sit on the sidelines as legislators and regulators fashion the legal and regulatory framework within which they will operate for years to come. There is no doubt that some firms actively seek government favors and handouts; this is what my Mercatus Center colleague Matthew Mitchell refers to as "The Pathology of Privilege." This kind of rent-seeking is anathema to free markets and a growing economy.

But at the same time, much of what firms in highly-regulated industries do isn't about protecting privilege--it's fighting for the ability to keep their doors open instead of being put out of business by ill-conceived regulations.

It will take a lot more nuanced legwork to determine how much business lobbying is defensive and how much is geared toward grabbing government handouts. We do not need to figure that out before undertaking to limit the government's ability to grant favors and impose distortive regulations. Getting the government out of business will enable companies and their executives to concentrate on meeting the needs of consumers in the marketplace rather than meeting politicians and regulators in government's corridors.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.