Regulatory Shocks: Forms, Dynamics, and Consequences
Summary and Keywords
Regulatory shocks, either by imposing regulations or easing them (deregulation), yield abrupt and fundamental changes to the institutional rules governing competition and, in turn, the opportunity sets available to firms. Formally, a regulatory shock occurs when jurisdictions replace one regulatory system for another. General forms of regulation include economic and social regulation but recent work offers a more fine-grained classification based on the content of regulations: regulation for competition, regulation of cap and trade, regulation by information, and soft law or experimental governance. These categories shed light on the types of rules and policies that change at the moment of a regulatory shock. As a result, they advance our understanding of the nature, scope, magnitude, and consequences of transformative shifts in rules systems governing industries. In addition to differences in the content of reforms, the assorted forms of regulatory change vary in the extent to which they disrupt an industry’s state of equilibrium or semi-equilibrium. These differences contribute to diverse temporal patterns or dynamics, an area ripe for further study. For example, a regulatory shock to an industry may be followed by rapid adjustment and, in turn, a new equilibrium state. Alternatively, the effects of a regulatory shock may be more enduring, contributing to ongoing dynamics and prolonging an industry’s convergence to new equilibrium state. As such, regulatory shocks can both stimulate ongoing heterogeneity or promote coherence within and among industries, sectors, organizational fields, and nation states. It follows that examining the content, scope, and magnitude of regulatory shocks is key to understanding their impact.
Since conforming to industry regulation (deregulation) increases economic returns, firms attempt to align their policies and behaviors with the institutional rules governing an industry. Thus, regulatory shocks stimulate the evaluation of strategic choices and, in turn, impact the competitive positions of firms and the composition of industries. Following a shock, at least two generic cohorts of firms emerge: incumbents, which are firms that operated in the industry before the change, and entrants, which start up after the change. To sustain a position, entrants must build capabilities from scratch whereas incumbents must replace or modify the practices they developed in the prior regulatory era. Not surprisingly, the ensuing competitive dynamics strongly influence the distribution of profits observed in an industry and the duration of firms’ profit advantages.
Our review highlights some of the prominent areas of research inquiry regarding regulatory shocks but many areas remain underexplored. Future work may benefit by considering regulatory shocks as embedded in a self-reinforcing system rather than simply an exogenous inflection in an industry’s evolutionary trajectory. Opportunities also exist for studying how the interplay of industry actors with actors external to an industry (political, social) affects the temporal and competitive consequences of regulatory shocks.
Regulation and Regulatory Shock
It is widely accepted that a fundamental regulatory reform or change, whether constraining or enabling, can dramatically transform industries and the organizations operating within them (Joskow & Noll, 1981; Peteraf & Reed, 2008; Reger, Duhaime, & Stimpert, 1992; Stigler, 1971; Winston, 1998). Given that regulatory shocks, whether positive or negative, interrupt and shift the evolution and development of industries and firms, management and strategy scholars have long attended to them.
A regulation is a formal rule, prescribed by a government institution such as an administrative agency (e.g., Canada Industrial Relations Board (CIRB) or the Federal Financial Supervisory Authority (BaFin) in Germany) that governs organizational conduct in an industry or multiple industries with the force of law. Institutional actors often establish regulation (regardless of its scope) to enable stable relationships among firms, workers, and the state (Fligstein, 2002), and, in turn, to foster economic exchange. Additionally, the stability stemming from regulatory regimes may positively influence firm profits and viability, in contrast to the instability of environments devoid of regulation (Fligstein, 2002). Deregulation lessens the number of formal rules applied to an industry (or multiple industries), usually in an effort to improve economic performance. In solidifying a predictable set of market and non-market relationships, regulation enables economic actors to comprehend their opportunity sets. In contrast, deregulation loosens the constraints circumscribed by regulatory regimes, potentially shifting the balance of power between private and social well-being (North, 1990). A move toward a more deregulated environment thus reduces a state’s or institutional actor’s intermediate role between a firm’s principals and agents.
Unsurprisingly then, many scholars see regulatory shock as a shift from regimes with stringent rules that dampen rewards for firms’ successful competitive strategies (Smith & Grimm, 1987) to more liberal ones that promote entry and ensure access to free competition (Bartle, 2002; Levi-Faur, 2005; Schneiberg & Bartley, 2008; Vogel, 1996). Just as importantly, this dichotomy is characterized as constraining innovation strategy and firm performance on the one hand (Smith & Grimm, 1987), versus enabling better service and alignment with consumer tastes or values (Peteraf & Reed, 2007) on the other.
Regulatory Shock: Form and Content
Nonetheless, the literature offers additional classifications of regulations that hint at a more complex understanding of regulatory action: economic regulation and social regulation. The first refers to policy regimes that guide competitive behavior within an industry (or multiple industries) whereas the second guides functional activities that focus on non-economic outcomes across industries (such as environmental protection, safety, or health) (Schneiberg & Bartley, 2008). Examples in the United States include the economic regulation of air carriers (Civil Aeronautics Act of 1938) (Goetz & Sutton, 1997) and commercial and investment banking (e.g., via the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010), as well as social regulations such as the Occupational Health and Safety Act and the Clean Air Act, both passed in 1970.
Recent studies (centering on regulatory developments since the end of the 20th century), build upon these descriptions with four new categories of regulation: regulation for competition, cap and trade, regulation by information, and soft law or experimental governance (Schneiberg & Bartley, 2008) (see Table 1). Governments enact regulation for competition to define the boundaries of industries, ensure fair rates, and sanction fraudulent or anti-competitive behavior. Additionally, regimes may combine regulation of competition (e.g., oversight of mergers or concentration) with regulation for competition, where governments intercede to foster competitive markets (Jordana & Levi-Faur, 2004; Majone, 1997; Henisz, Zelner, & Guillén, 2005). In a different vein, cap-and-trade regulation more narrowly concerns policies and laws that guide firms’ actions (e.g., trading carbon emissions credits to manage the real costs of climate change) via market-based solutions. In the case of regulation for information, policymakers mandate the release and dissemination of information to consumers, investors, or advocacy organizations that, in turn, drive enforcement (Fung, Graham, & Weil, 2007; Majone, 1997; Slaughter, 2004). Enforcement mechanisms manifest most frequently as lawsuits, community pressure, or public protest. Finally, soft law (or experimental governance) creates regulatory frameworks that are flexible or negotiated. This regulatory approach encourages standard setting and frequently results in an “industrial morality” (Rees, 1994) fostered and shared among members of the industry or sector. (See Schneiberg & Bartley’s, 2008 review for more on these groupings.)
Table 1. Forms of Regulation: Definitions and Examples
General Forms of Regulation
Social: Policies that guide functional activities and focus on non-economic outcomes (such as environmental protection, safety, or health).
EU General Data Protection Regulation (GDPR) of 2016 (enforceable as of May 25, 2018) is a regulation on data protection and privacy for all individuals within the EU.
The World Health Organization (WHO) develops international norms and standards to assist countries in strengthening the regulation of medicines, vaccines, and medical devices, and in eliminating substandard and falsified medicines.
Economic: Policy regimes that guide competitive behavior in an industry.
The U.S. Airline Deregulation Act of 1978 removed federal governmental control over issues such as pricing, routes, and the entry of new firms.
The 1988 law of the People’s Republic of China on Chinese–Foreign Contractual Joint Ventures is intended to expand economic and technological exchange with foreign countries by promoting Chinese–foreign joint ventures.
Specific Forms: Content of Regulations
Regulation for competition: Used to define industry boundaries, ensure fair rates, and sanction fraudulent or anti-competitive behavior. May be combined with regulation of competition (oversight of mergers and acquisitions).
Deregulation of the U.S. interstate trucking industry via the Motor Carrier Act of 1980 reduced entry barriers, price controls, and collective price setting.
Regulation of cap and trade: Policies and laws that guide firms’ actions via market-based solutions.
The EU’s Emissions Trading System (ETS) was launched in 2005 to reduce greenhouse gas emissions. The cap is a limit set on the total amount of greenhouse gases that can be emitted by participating installations; organizations pay a penalty if they exceed the cap. Organizations may buy and sell (trade) allowances for emissions.
Regulation by information: Policymakers mandate the release and dissemination of information to consumers, investors, or advocacy organizations that, in turn, drive enforcement.
The Environmental Information Regulations (EIR) of 2004 is a U.K. statutory instrument (defined by the U.K. as an executive order, regulation, rule, scheme, or bylaw) that provides a statutory right of access to environmental information held by British public authorities.
Soft law or experimental governance: Creates regulatory frameworks that are flexible or negotiated; encourages standards setting and frequently results in “industrial morality” fostered and shared among members of an industry or sector.
The UN’s’ Universal Declaration of Human Rights of 1948 serves as a foundation for international human rights law and has contributed to legally binding international human rights treaties.
Fair trade organizations, such as the World Fair Trade Organization (WFTO), operate to promote awareness, support producers, and campaign for reforms in rules and practices to advance equity in international trade.
These categories of regulatory action underscore key attributes that shift at the moment of regulatory shock, attributes that might be lost with a dualistic view of regulatory reform. Specifically, rather than simply overseeing a loosening (or tightening) of regulation, this view emphasizes changes in the content of the rules and laws (who or what is limited or enabled); these material differences in policy regimes reorganize the opportunity sets and the relative strength of actors in the focal industries. Moreover, rejigged regulatory structures may extend their influence beyond industry players to varied actors across an entire organizational field. Regulation for competition offers an exemplar. Levi-Faur (1999) describes the transformation in policy regimes governing the telecom industry in Europe in the 1990s from an industry composed of nation-specific monopolists to a more liberal and competitive one spanning many countries. In particular, new regulation mandated that providers maintain rate and cost transparency and that there be safeguards for equal network access by telecom operators across Europe, all while extending consumer choice. Thus, this shift was not from strict laws to few or no regulation, but rather to a different type of regulation, applied to actors in an expanded set of domains. To wit, these rules emerging from regulation for competition in the telecom industry redefine the relationships between rivals, consumers, watchdogs, and regulators in multiple jurisdictions. Overall, these newer categorizations of regulation assist in our understanding of the potential nature, magnitude, and scope of regulatory shocks.
Relatedly, this more nuanced view of regulation renders moot more normative evaluations of regulatory shifts. Some economists cast regulation as a method that perniciously enables rent-seeking behavior, whereas others (namely political economists and sociologists) submit the contradictory view that regulation enables flourishing markets (Fligstein, 2002; North, 1990). Deploying these newer categorizations of regulation cannot resolve this debate. Studies on regulatory shocks informed by the categories, however, leads to richer questions as to the consequences of shifting regulatory regimes. For instance, research that attends to the content of fundamental regulatory change as well as the conditions under which different actors, communities, or organizations benefit (or suffer) offers more definitive conclusions and guidance.
Regulatory Shock as a Form of Environmental Shock
A regulatory shock occurs when jurisdictions replace one regulatory system for another. The regulatory environment includes aspects of legislation, regulation, and policies relevant to an industry (Barr & Huff, 1997; McCutchen, 1993). Regulatory structures form part of the set of contingencies with which firms (and other actors in a field) must contend (Meyer, 1982; Meyer, Gaba, & Colwell, 2005; Thompson, 1967). The source of regulatory change may be exogenous, where actors external to an industry initiate and define the new rules governing competition. However, regulatory change also may be endogenous, where firms operating in an industry play a stronger role than external actors in initiating and shaping regulation (Peltzman, 1993; Stigler, 1971). Transformative regulatory jolts, however, more often arise from exogenous sources than endogenous ones. Other general environmental characteristics include the stage in the product or industry life cycle and a broad range of economic and societal trends. Similar to all environmental shocks, regulatory shifts vary in magnitude, levels affected, and temporality (see Table 2 for a summary).
As suggested, when regulatory reform involves a radical departure from existing rules governing industry competition, it destabilizes an industry and resets its evolutionary clock. These conditions typically contribute to a massive shift in an industry’s structure of competition (e.g., Joskow, 2005; Winston, 1998), largely due to a change in the composition of players in the industry (via entry and exit), the balance of power among institutional actors, and the dimensions of competition (Madsen & Walker, 2007, 2017). For example, Galvin (2002) exposes the unpredictable dynamics among a wide set of institutional actors set off by the passage in 1965 of Medicare and Medicaid legislation in the United States. In this case, the new regulatory regime represented a major shift, a radical reorganization (Carroll, Delacroix, & Goodstein, 1988; Galvin, 2002), from a system dominated by the medical profession and supported by government to a system in which the federal government’s influence and intervention supplanted that of the professionals. Under this different regime, the federal government established and enforced organizational practices and, throughout the country’s medical system, medical professionals obligingly followed.
Naturally, a regulatory shift need not be as radical as the example of U.S. Medicare and Medicaid legislation. In some instances, new regulatory frameworks represent adjustments in scope or in enforcement mechanisms. In these cases, the general content of the schemes may be minimal but policymakers revise credible deterrents or punishments, increasing the coercive power of the regulation. Thus, the magnitude of regulatory shock may be relatively small, yet still inspire new action from firms. In 2006, after several years of unsuccessful efforts, Chinese regulators adjusted sanctions for firms caught tunneling (expropriating corporate assets via theft or self-serving financial transactions) (Haß, Johan, & Müller, 2014). Rather than rely on civil litigation, which seemed to have little effect, regulators moved to a new public enforcement mechanism: publication of a “blacklist” of violators. The blacklist was unprecedented; it represented a newly credible commitment to enforcement and a genuine threat to corporate reputations. It is noteworthy than even with such a small regulatory shift, tunneling decreased, performance improved, and the stock market responded favorably. In sum, similar to other forms of environmental shocks, the contrast or magnitude of difference between preceding and current policies remains a key aspect when considering the impact of regulatory reform.
Diffusion, Multilevel Effects, and Interdependencies
Further, recent scholarship highlights various aspects of regulatory regimes, such as the role of diffusion, multilevel effects, and interdependencies among actors, that extend to regulatory shocks as well. A shock created at the onset of regulation (or deregulation) may be viewed as occurring within a single level (local jurisdiction or state or nation) or across levels (local to state to nation to international). Such shocks may yield similar or differential effects within or among levels.
In the within-level case, studies make clear that the diffusion of regulatory reform across jurisdictions, whether mimetic or due to learning, is a common feature for most modern regulatory change. In an analysis of various sectors across 17 countries, Gilardi (2005) concluded that the adoption rate for regulatory policy increased with the prevalence of those policies among proximate nations. Likewise, regulatory adoption among South and Central American countries between 1979 and 2002 followed similar patterns, even after parsing out cross-sector diffusion within nations and within-sector diffusion across nations (Jordana & Levi-Faur, 2005). Thus, even if a regulatory shock begins at one level or in one area, we would expect the shock to soon extend to others. Moreover, Schneiberg and Bartley (2008, p. 33) posit that this pattern of regulatory spread is likely not new, in that earlier “regulatory forms might have arisen from transnational crossings” as well as through “diffusion across states.”
In contrast, fundamental regulatory transformation can trigger regulatory heterogeneity, rather than coherence, within and among jurisdictions or levels of analysis. While the deregulation of medical marijuana in the United States has diffused to 26 states (as of September 2016), all states have adopted different rules and policies. The stigma and uncertainty associated with the industry has also stimulated heterogeneous regulatory rules and policies at local and county levels within states. For instance, differences exist in multiple areas such as the medical conditions approved for usage, type of products that may be sold (flower, concentrate, etc.), amount of product that may be held by a patient, forms of distribution and sale, whether vertical integration is required or not allowed, and so on.
Furthermore, interdependence, whether regionally or industrially based, also increases the multilevel effects of regulatory change. Coordinated regional regulatory oversight is not a new policy approach. For instance, in 1922 seven U.S. states within the Colorado River Basin negotiated the Colorado River Compact (U.S. Department of the Interior, Bureau of Reclamation). The agreement governs allocation of water rights among those states, affecting both public agencies and private firms (such as agribusiness and developers). However, what is perhaps less appreciated is the emergence of interdependencies grounded in collaborative transnational structures creating multilevel regulatory regimes and platforms. These global coordination efforts such as the United Nations (UN), North American Free Trade Agreement (NAFTA), or the Paris Climate Agreement enact policies governing firms’ and industries’ actions at the global, national, and state levels. Thus, when the European Union’s (EU’s) Commission Implementing Regulation—an international agency—harmonizes rules for application within the market (e.g., labeling requirements for gluten-free foods), a single regulatory change touches all 28 member countries across multiple industries (e.g., beer brewers, infant formula manufacturers, and bakers) (Official Journal of the European Union, 2014). Thus, like regulation itself, the influences of regulatory shocks may extend horizontally and vertically, regardless of magnitude or content.
At first blush there seems a clear if implicit agreement as to the temporal dynamics at play at the moment of a regulatory shock. The word “shock” conveys the idea of a surprising disturbance, an inflection point in the current trend. And yet scholars hold little consensus as to the temporality of regulatory events. Empirically, studies frequently analyze outcomes in eras before and after a regulatory shift to proxy for the effects of significant institutional change, but analytical frames vary. The divergent views fall into three groups: regulatory reform as a punctuated event, as adding to an industry’s normal state of flux, or as triggering an ongoing change and adjustment process. We explain each in turn.
In perhaps the most common assessment, regulatory shocks are unexpected and discontinuous perturbations in a regulatory environment. Moreover, as Meyer (1982) explains, these jolts are transient events that harbor disruptive and harmful consequences for organizations. Importantly, these types of sharp, sudden regulatory changes typically prohibit firms from implementing incremental strategic adjustments (Goll & Rasheed, 2011). From this perspective, regulatory reform occurs at a specific moment in time, where the static states of the world before and immediately after that moment contrast sharply.
An industry’s rate of recovery from the new world or regulatory regime varies. When firms can readily adjust to the new rules, volatility dampens in the short run and the industry quickly approaches a new equilibrium state. In contrast, when adjustment requires more time, a state of flux endures long after a shock’s initial impact. In the latter case, a shock presents an inflection point that fosters uncertainty and change in a more ongoing way. Under these more dynamic conditions, adjustment to reforms often occurs iteratively over time. For example, Marcus (1988) documents that nuclear power plants showed “rather slow adjustment” in the post-Three Mile Island regulatory era. Moreover, ostensibly after completing their adoption of newly required practices, in many cases nuclear power plants still maintained incomplete or inaccurate technical specifications. As this case illustrates, while the change in regulation constitutes a “triggering event” (Hoffman, 1999), instability follows for an unspecified amount of time.
In the final perspective, researchers describe the temporal character of regulatory change as one part of an industry’s ongoing dynamics. This applies to both activities pre- and post-reform. Similar to other political processes, a regulatory shift does not occur overnight; lawmakers and regulators dismantle previous regimes through a series of negotiations, and in many instances firms (or their surrogates) engage actively in these activities. Moreover, the pathway to new regulation may not be regular or linear, heightening ambiguity prior to enactment. Madsen and Walker (2017, p. 190) describe the situation in the long haul trucking industry: “Piecemeal plans made by the ICC in late 1970s coupled with the chance that the U.S. courts or Congress could step in and modify or reverse these plans created substantial uncertainty for both Incumbents and Entrants regarding how deregulation ultimately would roll out.”
In addition, firms’ reactions and the cascading consequences within an industry may evolve over time, extending the duration of a new regulation’s impact. Barr and Huff’s (1997) study of pharmaceutical firms suggests that the pressure to change builds gradually as firms wrestle with the different beliefs and mental models required for strategic adjustments. To wit, many airlines did not wait to begin their responses to deregulation (Cheng & Kesner, 1997) and yet, two decades later, the industry still was discarding inefficiencies and recognizing new ways to market (Winston, 1998). Further, firms as a whole may not act simultaneously, with some cohorts (e.g., new entrants versus incumbents) demonstrating different rates of adoption and adjustment (Madsen & Walker, 2015) and, in turn, advancing different competitive contests. Such contexts may reveal different challenges associated with particular rules and policies and, in turn, stimulate revisions to those policies, prolonging the recovery process. Thus, even though significant theoretical and empirical interest in regulatory shocks exists, there remains a variety of views as to the temporal dynamics at work both before and afterward.
Table 2. Regulatory Shocks: Primary Attributes
May be exogenous or endogenous; some reforms may involve both sources.
Ranges from a radical departure from existing rules (destabilizing) to incremental (such as adjustments in scope or enforcement mechanisms).
Level of impact
Occurs within a single level (such as within a local jurisdiction or state, or nation) or across or among levels (such as local jurisdiction to state to nation to multi-nation).
Regulatory reform as: (a) a punctuated event (at a point in time), (b) as adding to an industry’s normal state of flux, or (c) as triggering an ongoing change and adjustment process.
Regulatory Shock: Consequences
Given that a firm’s strategic goal is to identify the most favorable match between (internal) organizational resources and external contexts, regulatory shocks coincide with dynamic strategic positions (Zajac, Kraatz, & Bresser, 2000). Consequently, scholars in strategy and organizational theory posit that organizations must adapt to variation in their environment (whether legal, regulatory, or otherwise) or face demise (Aldrich, 1999; Brittain, 1994). This section focuses on strategic initiatives that firms implement in response to shifts in the regulatory environment and the consequences for competitive advantage and competitive heterogeneity.
Nonetheless, it is worth acknowledging that there may be non-competitive outcomes resulting from a regulatory shock. For example, firms could take actions not explicitly required by new legislation or necessary to improve their competitive positions. As one example, Edelman (1990) found that after the civil rights legislation in the 1960s many firms adopted formal grievance procedures for their employees even though such steps were not required by law. Other research shows how new regulatory requirements influenced organizational structure and procedures such as personnel departments, rulebooks, and internal labor markets (Baron, Dobbins, & Jennings, 1986), as well as hiring practices (Guthrie, Grimm, & Smith, 1991). Further, regulation may spawn new coalitions, that is, interest groups (e.g., labor or consumers) that shift social or political power across an organizational field (Schneiberg et al., 2008). Staber and Aldrich (1983), for instance, suggest that an increase in trade associations stemmed from belief that over-regulation hindered firm performance and, therefore, was partially a collective effort among firms to influence regulatory structures (Galvin, 2002). While these dynamics represent crucial aspects of the reaction to regulatory shocks, the scope here limits us to consider only the regulatory consequences for firm strategy and competition.
The introductory section highlights how regulatory shocks, as key elements of a firm’s environment, shape the opportunity sets and strategic constraints available to firms. More specifically, the shift in regulatory policies spurs the fresh evaluation of strategic choice (Peteraf & Reed, 2007). In this vein, research shows that firms answer regulatory changes by shifting their generic strategies (Smith & Grimm, 1987; Zajac & Shortell, 1989), especially if they perceive a benefit to their welfare and experience multiple signals of the need for strategic change (Barr & Huff, 1997; Hutzschenreuter & Israel, 2009). For example, in an early study McCutchen (1993) found that following the implementation of a research and development (R&D) tax credit, pharmaceutical firms increased research intensity (research/sales) in association with the adoption of the tax credit. Just as importantly, not only did the firms shift R&D investments in alignment with the new policies, they also did so in an effort to maintain their relative position in research intensity compared to rivals within the industry.
Prior work yields several key findings about the consequences to firms’ competitive positions after responding to regulatory shock. First, fundamental regulatory change in the form of deregulation often promotes inefficient practices in the short run (Delmas & Tokat, 2005), whereas tighter regulatory controls tend to encourage inefficient behavior in an ongoing way (Joskow, 1974; Posner, 1974; Stigler, 1971; Winston, 1998). Second, following a regulatory shock, two generic cohorts of competitors emerge: incumbents, which are firms that operated in the industry before the change, and entrants, which started up after the change (Klepper, 2002; Madsen & Walker, 2007). Third, because the opportunity set is altered by a regulatory shock, both incumbents and entrants encounter challenges that differ from those that incumbents faced in the earlier regulatory regime (Haveman, Russo, & Meyer, 2001; Kim, 2013; Thomas, 1990). To adapt and survive, entrants must build capabilities de novo, while incumbents, in contrast, must replace or modify their traditional routines developed in the previous era. These conditions yield heterogeneous responses from firms and set the stage for intense and ongoing rivalry (Delmas, Russo, & Montes-Sancho, 2007; Dobbin & Dowd, 1997).
Strategic Response and Competitive Advantage
Scholars have long attended to the positive relationship between organizational change and performance after regulatory shifts. Notable examples are Smith and Grimm (1987) evaluating enhanced performance in the railroad industry after deregulation, Marcus (1988) examining the implementation of regulation and safety performance in nuclear power plants, and Haveman (1992) documenting the benefit to performance and survival from regulatory shifts in the savings and loan industry. This line of research does reveal when new strategic actions stemming from regulatory shocks generally yield improved outcomes for firms. First, changes that match both the new regulatory environment and a firm’s own competencies can enhance performance and survival (Haveman, 1992). Specifically, when new strategic actions, enacted to respond to regulatory pressures, align with existing resources or core technology, outcomes for firms improve. Second, firms with more flexible strategies in general are more able to respond successfully to a fundamental change in the regulatory environment (Smith & Grimm, 1987). Finally, implementation of new strategic initiatives leads to better outcomes when main line managers are free to design and determine the specifics of the implementation (Marcus, 1988). In fact, when studying power generation before and after deregulation, Peteraf and Reed (2007) conclude that costs are lowest for firms when managers are able to use their discretion to match practices with the regulatory era.
More recent work, however, exposes the boundary conditions of the effects of different legal requirements. To wit, Fremeth and Shaver (2014) found that U.S. electric utility firms complied with extra-jurisdictional technology requirements in anticipation of potential regulatory changes in the states where they operate. Also, studying Chinese firms’ adaptation to pro-market reforms, Banalieva, Eddleston, and Zellweger (2015) found that firm performance varied by the speed of reform, and that non-family firms more easily aligned with the new regulatory regime and thus experienced better performance. Other work exposes unintended or surprising competitive consequences in the wake of transformative regulatory reform. Mingo and Khanna (2014) show that ethanol plants founded during Brazil’s Pro-Alcohol Market Intervention Program tend to be, in the long run, surprisingly more productive than those founded before the program was in place. In another instance, in the U.S. telecommunications industry, the breakup of AT&T (mandated to eliminate its monopoly) ultimately benefitted AT&T (Haveman et al., 2001) rather than Baby Bells. Thus, while firms that align their strategic actions with the mandates of the new regulatory regime generally enjoy better performance, differences in arrangements within firms can nevertheless reduce the effectiveness of their strategic actions.
As firms individually adjust and jockey for position in a new regulatory era, the structure and competitive heterogeneity within the industry adjusts in kind. Following deregulation, the net result of firms’ new competitive moves (such as entry, exit, and mergers) creates fiercer competition regardless of whether the total number of firms in a market rises or falls (Winston, 1998). Furthermore, there may be more volatility in the years immediately following, leading to periods of repeated adjustment (Thomas & D’Aveni, 2009; Madsen & Walker, 2017).
As stated, following a regulatory shock, two generic cohorts of competitors emerge: incumbents, which are firms that operated in the industry before the change, and entrants, which started up after the change (Klepper, 2002; Madsen & Walker, 2007). At least four conclusions emerge from empirical work that examines industry conditions after a regulatory shock (particularly deregulation): (a) the patterns of performance heterogeneity among cohorts of firms, entrants and incumbents, differ fundamentally (Henry, Grabowski, Vernon, & Thomas, 1978; Madsen & Walker, 2017; Thomas, 1990; Walker, Madsen, & Carini, 2002); (b) entrant’s profit advantages are more temporary than those of incumbents’ (Madsen & Walker, 2017); (c) incumbents’ capabilities tend to be more powerful determinants of performance differences as compared to those of entrants in the short run (Madsen & Walker, 2017); and (d) incumbents, while slow to adjust, often are more resilient than large entrants (Thomas, 1990) and yet, they (as a group) experience a dramatically lower survival rate than in earlier regulatory periods (e.g., Gruca & Nath, 1994; Haveman et al., 2001; Silverman, Nickerson, & Freeman, 1997). In sum, regulatory shock strongly influences the distribution of profits observed in an industry and the duration of firms’ profit advantages.
As regulatory regimes continue to enable or constrict organizational structures and strategies as well as to mold industry structures and trajectories, future research is vital in understanding the organizational consequences of these activities. While this discussion summarizes what is understood about regulatory shocks and their consequences for firms, strategy, and industries, several areas for future research remain.
Little clarity or consensus around the temporal patterns spawned by regulatory shocks exists, suggesting a fruitful area for further examination. Conceiving of regulatory change as an evolutionary inflection or embedded in a self-reinforcing system as opposed to an exogenous punctuation that disrupts a system in equilibrium has considerable theoretical and empirical import. In particular, conceptual models and analysis methods that embrace nonlinear ideas, such as complex adaptive systems, may be closer to social, political, and industrial realities (Meyer et al., 2005) and therefore more appropriate. Furthermore, regardless of the temporal view of the shock itself, the literature makes it clear that firms do not adjust instantaneously, but rather may act in anticipation of, concurrent to, or in answer to regulatory change (e.g. Delmas, Russo, & Montes-Sancho, 2007; Fremeth & Shafer, 2014; Winston, 1998). The ramifications, however, of these differently timed moves is unclear. In short, a regulatory shock’s timing, and the consequences of the timing on firm actions and competitive positions, remain under-examined.
Additionally, previous research tends to rely on familiar contexts for examining regulatory regime change. The United States, especially during the 19th and 20th centuries, forms the typical base case for theorizing regulation’s emergence and effects (Schneiberg & Bartley, 2001). While some recent research does expand to other contexts (e.g., Levi-Faur, 2005; Majone, 1997), it largely remains limited to examining the emerging forms of regulation and not the subsequent firm actions, performance outcomes, or ramifications for industry structure. Moreover, settings with various levels of institutional strength, such as emerging markets or regions with unstable or weak institutions, remain under-examined.
Furthermore, more questions remain as to the interplay among the various social and political actors that represent the interests of critical industry players (Galvin, 2002). Given that the newer forms of regulation—regulation for competition, regulation for information, cap and trade, and soft law (or experimentalist governance)—rely increasingly on actors that extend beyond industry rivals (e.g., advocacy groups, professional associations, policymakers), a deeper examination of the competitive consequences of these forms is called for. As we are at the frontier of enacting these new regulatory arrangements, how these forms shape firms’ opportunities and constraints and mold modern industries remains unknown and unexamined.
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