For capture to be sustainable, the regulator has to find ways to be perceived as being tough on the regulated without really hurting them.
The regulatory-capture strand((George Stigler, The Theory of Economic Regulation, 2 Bell Journal of Economics 3 (1971).)) in economics has greatly advanced our understanding of regulatory behavior. Yet one important aspect has been left underappreciated, namely, how regulators manage their reputations. Reputation is frequently mentioned as a trump card against assertions of capture: regulators care about maintaining a reputation for doing a good job, the argument goes, and this pushes them toward protecting the public interest even in the face of pressures from special interests. What the reputation-as-antidote-to-capture argument misses is that regulators seldom take their reputation as given. Regulators can manage public perceptions of them in various ways. They can score points in the court of public opinion for protecting the public interest, without actually protecting it.
For example, under certain conditions, both the regulator who plays favorites with the industry, and the industry he plays favorites with, have incentives to fight each other in public. By publicly locking horns, the regulator and regulated reduce the risk of backlash (that is, the risk that the regulators’ overseers will interfere and demand new/harsher regulation). In countless movies and novels, there appears a similar trope that is termed “make it look like a struggle.”((It even has its own wiki-tropes page: http://tvtropes.org/pmwiki/pmwiki.php/Main/MakeItLookLikeAStruggle.)) You have probably seen the story before: our hero is captured by some bad guys, but the guy who guards him wants to let him escape. The problem is that the guard does not want the other bad guys to think of him as a traitor. So our hero and the guard come to an agreement: “give me a black eye to make it look like a struggle”/“trash the room to make it look like a burglary”/or other variations.
The analogy to regulatory behavior is that for capture to be sustainable, the regulator has to find ways to be perceived as being tough on the regulated without really hurting them. By nature, actual evidence of such make-it-look-like-a-struggle dynamics is hard to come by. But over the years I collected implicit admissions by the regulators or regulated, as well as some stylized facts that fit the theory. Consider the five following examples from myriad contexts of regulatory behavior.
The first suggestive example comes from the first federal regulatory agency, the Interstate Commerce Commission (ICC), originally meant to regulate the railroads to protect consumers. In a story that has by now made it to the popular press and the Regulatory Capture Wikipedia page, Richard Olney, a railroad lawyer turned attorney general at the Cleveland Administration, told railroad officials that the smartest strategy to combat the new regulation is making it look like a struggle: “The Commission… is or can be made, of great use to the railroads. It satisfies the popular clamor for a government supervision of railroads, at the same time that that supervision is almost entirely nominal… The part of wisdom is not to destroy the Commission, but to utilize it.”
A second admission, this time more direct, comes from a former general counsel of the Environmental Protection Agency (EPA). The former public official claimed that chemical companies and the EPA engage in a Kabuki ritual: to answer demands for transparency they put on a show of having some of their communications out in the open, while keeping the more crucial communications behind closed doors((Wendy E. Wagner, Administrative Law, Filter Failure, and Information Capture, 59 Duke Law Journal 1321, 1366 (2010).)). The process gives the public and the EPA’s political overseers the perception of an exchange of ideas disinfected by sunlight, while all the time the meaningful exchanges are done in the dark.
A third indication comes from the two-prong puzzle of corporate law((For elaboration see Roy Shapira, A Reputational Theory of Corporate Law, 26 Stanford Law & Policy Review 1 (2015), especially in section IV.B.)): Delaware courts refrain from imposing sanctions on directors for mismanaging companies((Margaret Blair & Lynn Stout, Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law, 149 University of Pennsylvania Law Review 1735, 1791 (2001) (directors are more likely to get struck by lightning than pay damages for breaching their fiduciary duties).)), but at the same time deliver lengthy, detailed opinions with caustic criticisms of director behavior((Edward B. Rock, Saints and Sinners: How Does Delaware Corporate Law Work?, 44 U.C.L.A. Law Review 1009 (1997).)). Why bother barking so hard if you are not going to bite? One possibility is that public scolding helps Delaware balance between catering to the public and catering to corporate America. The public scolding gets picked up by the media and reduces the risk that Delaware courts will be perceived as under-regulating, which in turn reduces the risk of getting overruled by Washington((Mark J. Roe, Delaware’s Competition, 117 Harvard Law Review 588 (2003) (explaining how even though corporate law is dictated at the state level, any state that wins the “competition” over where corporations incorporate is subject to the risk of being overruled by Washington, which affects how states govern ex ante).)). At the same time, corporate managers are not forced to pay out of pocket, which reduces the risk that they will migrate away from Delaware, thereby keeping incorporation fees in Delaware. In other words, public scolding drives a wedge between perceived enforcement and actual enforcement. It is perceived as more of a struggle than it actually is.
Fourth, consider the heated debate over the Securities and Exchange Commission (SEC) enforcement actions. The SEC’s settlement practices have been the subject of mounting criticisms, directed at the practice of filing enforcement actions only to settle them immediately without requiring admission. To protect their reputation against such claims of under-regulating, the SEC marshalled numbers showing a steady increase in the number of cases brought and fines collected through these settlements. The SEC were right to claim that SEC settlements rarely leave money on the table. But they missed how neither-admit-nor-deny settlements leave information on the table. As I detail elsewhere((Shapira, A Reputational Theory of Corporate Law, especially in part V.)), both the SEC and big-firm defendants have incentives to settle quickly and for high amounts in exchange for limiting the public release of damning information. Companies get to brush off the relatively modest legal sanctions as the costs of doing business, while watering down the potentially much bigger reputational sanction. And the regulator gets to tout meeting observable yardsticks (number of cases brought, amount of fines collected) in front of its overseers in Congress.
As the Delaware courts and SEC examples illustrate, certain practices (public scolding, limited-information settlements) can create a wedge between real and perceived enforcement consequences. Our final example points to a similar wedge created by the FDA enforcement actions. The FDA, studies show((Moshe Maor & Raanan Sulitzeanu-Kenan, The Effect of Salient Reputational Threats on the Pace of FDA Enforcement, 26 Governance 31 (2013).)), plays on a temporal gap between inspection and enforcement. Based on the level of media scrutiny, the FDA will increase the delay between the (more visible) inspection stage and (less visible) enforcement stage.
Two key caveats are in order: it is easy to overplay both the prevalence of make-it-look-like-a-struggle, and its actual impact. Make-it-look-like-a-struggle is very susceptible to turning into a just-so-story. Precisely because hard evidence on it is hard to come by, it is too easy to use make-it-look-like-a-struggle as a plug explanation. A regulator does not seem to be tough on the regulated? He is captured! A regulator seems to be tough on the regulator? He is captured (by making it look like a struggle)! This may lead to what Harvard’s Daniel Carpenter warned us about in his ProMarket blog post last week: failing to settle on robust measurements and indicators of capture. We have to be careful with conceptualizing and finding clear indications before rushing to evaluate regulatory behavior based on a making-it-look-like-a-struggle claim.
Second, make-it-look-like-a-struggle dynamics are not necessarily bad for overall welfare. Consider for example the possibility of populist pressures that create a risk of regulatory overreaction. Under such a scenario making it look like a struggle may actually increase overall welfare by mitigating undue pressures. This is what another ProMarket contributor, Chicago Law’s Omri Ben Shahar, alluded to when analyzing the recent GMO-labeling laws, namely, that camouflaged industry influence can be a good thing when it balances irrational populism.
My goal in calling attention to make-it-look-like-a-struggle dynamics is therefore more modest: to spotlight the tools that regulators can use to fend off threats to their reputations. Importantly, we can glean important insights from shifting our focus to the perception and visibility of different regulatory methods. After all, visibility is an important determinant of capture. And low-visibility favoritism may end up causing more rent-seeking.