Why Self-Regulation Can Pay Off

Written

Why Self-Regulation Can Pay Off

Companies that try to fix problems on their own may sidestep more onerous regulations in the future.
Image of bundle of plastic straws. Credit: Eric Gaillard
As cities pass new environmental regulations, companies may want to consider regulating themselves. | Eric Gaillard

There are many famous examples of industries and companies voluntarily going above and beyond government regulations.

For instance, the Motion Picture Association of America’s rating system restricts minors from seeing films with adult content. The Financial Industry Regulatory Authority instituted “circuit breakers” to prevent stock market crashes arising from high-frequency trading. And JUUL, the manufacturer of nicotine vaping devices, restricted in-store sales of sweet and fruity flavors that appeal to children and teenagers.

Why would these firms agree to go beyond the law, especially since they may be leaving some profits on the table? A common explanation for these forms of corporate social responsibility is that companies are able to project a favorable image to consumers and employees, providing an advantage in product and labor markets. This idea has been challenged in recent years, with some evidence showing that consumers are price sensitive and don’t care much about CSR.

In a paper recently published in the American Political Science Review (which I coauthored with professors Benoît Monin, an organizational behavior professor at Stanford GSB, and Michael Tomz, a professor of political science at Stanford University), we explore an understudied rationale for self-regulation. Firms may exceed regulation in order to reduce support for stricter regulations among key stakeholders, thereby forestalling future implementation of these regulations. In other words, firms may try to signal to citizens, activist groups, and politicians that they are attempting to solve the problem on their own, and that investment in onerous regulations is unnecessary. For instance, stock market circuit breakers may preempt government from taxing or even outright banning high-frequency trading. JUUL’s aim in restricting the sale of sweet and fruity flavors is to prevent stronger regulations such as banning all in-store sales or banning all flavored products, including mint and menthol.

To address this question, we administered experiments to stakeholder groups that often demand strict environmental regulation of companies: environmental activists, political officials, and ordinary citizens. We first asked people about their baseline support for various strict environmental regulation, such as the government banning the use of plastic packaging for foods and beverages. We then presented various ways that companies could self-regulate. For instance, they could engage in meaningful, deep regulation (making sure that their plastic containers have 70% recycled content) or weaker, shallow regulation (making sure that their plastic containers have 30% recycled content). Companies could either narrowly coordinate (with only 50% of companies agreeing to self-regulate) or broadly coordinate (100% of companies agreeing to self-regulate). We then re-asked people their support for the stricter government regulations under these conditions.

We found that self-regulation can be an effective corporate strategy, but the breath of self-regulation (the number of companies participating) mattered more than depth (the extent of self-regulation). In some simulations we conducted, we find that in the absence of self-regulation, pro-regulatory forces dominate in 68% of cases. If companies implement broad and deep regulations, this number drops to only 4%. However, companies can get it to as low as 16% by implementing broad but shallow regulations. In contrast, deep and shallow regulations only slightly reduce the chance of pro-regulatory domination.

What do our findings imply for corporate self-regulation as a means of making meaningful improvements to society? The answer is of course complicated given the costs and benefits of regulation. However, we can say that our results show that industry-wide greenwashing may be effective. What matters more to people is the percentage of an industry that is involved in self-regulation (perhaps because then it is a true substitute for public regulation) rather than what the companies are actually doing. This may make it more important for third-party bodies to monitor and audit the activities of companies and communicate this information to the mass public. We look forward to addressing these issues in future research.

This story was first published in Forbes.

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