"New era of government activism poses serious challenges to corporate leaders"
IMD Professor Carlos A. Primo Braga on regulation and license to operate
12 October 2015
Companies have to deal with negative perceptions in terms of public opinion (be it based on facts or sometimes on misunderstandings of how markets operate), differences in regulatory environments across jurisdictions (fostering regulatory arbitrage), and the growing complexity of regulation. For example, the Basel Accord of 1988 (Basel I) – the first international prudential regulatory agreement for the financial sector – was only 30 pages long. Basel II (2004) encompassed 347 pages. Basel III (2010), in turn, is 616 pages long. It is not only a question of quantity, but also of increasing complexity as illustrated by the exponential increase in the related calculations required to estimate risk weights for internationally-active banks.
This new era of government activism poses serious challenges to leaders in the corporate world. To ignore such a trend is myopic and may lead to an ever growing regulatory burden. To adopt a purely defensive approach, focusing on how to block regulatory change and on how to insulate companies from government intrusion increases the chances of a regulatory backlash in an environment dominated by negative perceptions about market-oriented solutions. Hence, the importance of engaging both at national and multilateral levels with a view to maintain the “corporate space” for companies to do what they do best: to promote innovation and growth. This is the focus of the conference “Regulation and License to Operate” at IMD on October 22nd.
IMD: Are there any lessons to be learned from the recent Volkswagen scandal about regulation and the license to operate?
Carlos A. Primo Braga: As the regulatory burden increases, leading to increased costs of compliance, the quality of corporate governance becomes even more relevant. It is still too early to identify the main culprits behind the illegal actions implemented by Volkswagen in trying to by-pass environmental standards. It seems to me, however, that if the marching orders from the top were not focused on growing market share no matter what (i.e., the target of becoming the largest auto producer in the world), the chances of choosing the illegal path would have been much smaller. If instead of becoming the biggest, Volkswagen management had chosen as its goal to become the most respected auto producer, the story would most likely have been a very different one.
In any case, the relevant lesson is that proper corporate governance and a culture characterized by transparency and respect for the rule of the law are critical ingredients for success. At the same time, proactive, early and principle-based engagement on difficult regulatory issues is more likely to establish the company as a credible interlocutor vis-à-vis regulatory authorities. Credibility leads to trust and influence. Needless to say, lost trust is difficult to regain.
IMD: Is there too much regulation? Are there too many regulatory bodies? Could more powerful globalized regulation bodies or multilateral rules solve some of these problems?
Carlos A. Primo Braga: The relevant question is not necessarily whether we need more or less regulation. After all, the answer should not be a matter of quantity, but quality. The objective should be to have regulations that incentivize proper behavior at the firm level, but that do not create an overall drag on the economy. In a globalized environment, the OECD exercise in tax policies, for example, may be the right approach since without general adherence to certain key elements you can create a ‘race to the bottom’ where those with responsible policies lose businesses to more lax systems with lower compliance costs. At the same time, it is important to recognize that simple rules often perform better than complex control regimes.
Multilateral disciplines can help in addressing distortions across different jurisdictions and in promoting international dialogue. One should, however, be careful not to force harmonization when alternative paths with lower transaction costs can be pursued. On regulation for data protection, for example, interoperability of regulatory systems should be a priority since complete harmonization is unlikely to happen in the near future.
At the conference, we will be discussing to what extent WTO or OECD disciplines, or new trade agreements (e.g., TPP) can advance an agenda of regulatory harmonization, while avoiding the creation of excessively complex regulatory frameworks.
Join us on October 22 for “Regulation and License to Operate” at IMD in Lausanne.
Find out more and register.