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Tom Lyon
  Thomas Lyon

Uncertainty Proves to be a Motivator for Self-Regulation

2/6/2006 --

Contrary to popular belief, regulatory threats that are distant or seem unlikely to materialize can sometimes motivate polluters to voluntarily institute self-regulation.

ANN ARBOR, Mich.—It is widely accepted that strong, credible regulatory threats are needed to motivate polluting companies to make "voluntary" environmental improvements.

However, new research conducted by Thomas Lyon of the University of Michigan's Stephen M. Ross School of Business suggests that even when regulatory threats appear relatively weak and uncertain, industry still might be motivated to take voluntary self-regulatory actions.

This revelation is particularly significant for "green" groups that lobby for tighter emissions standards and for regulators who propose mandatory pollution-control legislation.

In their study, Lyon and colleague John Maxwell of Indiana University examine two types of uncertainty. The first is the likelihood that a highly motivated advocacy organization will undertake the political effort required to push through new regulations. Since the costs of organizing a political campaign can be substantial, both in time and money, a green group is more likely to mount a lobbying effort if these so-called "political-entry costs" are low rather than high, they say.

The second type of uncertainty is the likelihood that legislation passes once a legislative proposal has been put forth.

"In practice, firms do not know with certainty the political costs facing advocacy groups," said Lyon, the Dow Professor of Sustainable Science, Technology and Commerce at the Ross School and co-director of the Erb Institute for Global Sustainable Enterprise.

"Furthermore, even after advocacy groups organize to enter the political arena, considerable uncertainty remains about whether they will be successful in passing legislation favorable to their cause. These two important uncertainties related to regulatory threats affect corporate environmental strategy."

For their analysis, Lyon and Maxwell use a model in which industry may take self-regulatory actions to pre-empt the imposition of a mandatory environmental regulation.

In the first stage, firms can choose voluntary abatement that pre-empts green-group political activity and prevents a legislative proposal from being introduced. In the second stage, if the voluntary abatement is not sufficient to pre-empt the green group's entry, the group incurs the cost of entering the political process, and the regulator puts forward a legislative proposal for mandatory controls. In the third stage, the regulator makes the proposal, which is passed and enforced.

The researchers report that in many circumstances, increasing the degree of either type of uncertainty can induce firms to undertake more self-regulation. At other times, however, greater uncertainty also can motivate companies to decrease their voluntary efforts. The key is to find the optimal level of action.

For example, if the political-entry cost for a green group is medium or high, a company may find it profitable to take pre-emptive self-regulatory actions that preclude the group from entering the political arena in the first place, even if the probability that legislation succeeds is small. At the other extreme, when mandatory regulation requiring industry abatement is almost certain to be imposed if industry takes no voluntary measures, firms again can find it profitable to pre-empt a green group through self-regulatory actions. In an intermediate situation, however, where pre-emption is not cheap and mandatory regulations are not highly probably, industry does not find pre-emption worthwhile.

"Our results suggest that during the policy life cycle, we may see pre-emptive voluntary action early on, followed by a period of industry quiescence, and then a second burst of activity later in the life cycle," Lyon said. "This phenomenon might help to explain why some voluntary self-regulatory actions are met with applause by green groups, while others are met with skepticism."

These findings also may impact the strategy of other players, Lyon and Maxwell say. For instance, professional environmental groups may strive to make their actions predictable while enthusiastic amateurs may want to seem unpredictable. Similarly, a green group, such as the Sierra Club, with a broad portfolio of diverse issues, may be better off to raise uncertainty about its future actions and claim to care about all the issues equally. A narrowly focused group, such as the National Audubon Society or the National Parks Conservation Association, would prefer to be predictable.

Written by Claudia Capos

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847