Regulatory Uncertainty and Nonmarket Capabilities

In 2005, the Economist Intelligence Unit conducted a survey with Chief Risk Officers worldwide across all industries and asked about the biggest threat to their businesses. Interestingly, regulatory risk ranked first. It dominated all other types of risk, be it related to reputation, IT, country, market, terrorism or many other causes (Economist, 2005). Apparently, uncertainty related to regulation is difficult for firms to accommodate and significantly influences business decisions. The motivation of the thesis is to shed light on the question of how firms cope with regulatory uncertainty. Furthermore, I want to explore whether this uncertainty is influencing investment decisions since these are key business decisions. To mitigate regulatory uncertainty a firm may address the nonmarket environment and try to influence policy-makers or regulatory authorities to drive policies and decisions in the desired way. Certainly, some firms may be more successful than others in doing so. Therefore, I argue that there is a set of different capabilities that are driving the effectiveness of these "nonmarket strategies" that allow the firms to mitigate risk from regulatory uncertainty. The thesis hence contributes to management literature about nonmarket strategies. I propose a set of capabilities that considers two different sources of value creation through nonmarket strategies. First, firms can create value from their nonmarket strategy by influencing the firm's non-business environment including policy-makers and regulators. Capabilities can be developed to shape policies, to influence regulatory decisions or to change regulatory institutions. I refer to these as "nonmarket capabilities". They help to mitigate the risk from regulatory uncertainty. My main hypothesis is that firms with stronger nonmarket capabilities are less likely to withhold investment because of regulatory uncertainty. Second, firms may also create value from their nonmarket strategy by organizational adaptation or exploitation of business opportunities that result from regulatory changes. I refer to the capabilities that help firms reach the aforementioned goals as "organizational capabilities". They capture the value of the firm's nonmarket action. Both nonmarket and organizational capabilities are analyzed empirically. The empirical analysis that was carried out in the liberalized European electricity generation market is twofold. First, interviews were conducted in the Swiss markets with the largest players. The results showed a high perceived regulatory uncertainty among the players, but with no indication that investment in generation capacity would be withheld. Investment delays are reported as well as a possible shift of upcoming investments to the bordering EU countries. The analysis of the interviews validates my proposed model since both nonmarket and organizational capabilities are developed by the Swiss players. Second, a survey was conducted into the European electricity generation market that encompasses the EU, Norway, Iceland, and Switzerland. The 300 largest generators were invited to contribute to the survey and the response rate reached nearly 30%. The survey results gave detailed information about the firms' capabilities to deal with regulatory uncertainty and with regulatory institutions, to exploit new business opportunities that result from regulatory changes and to adapt their organization to accommodate regulatory changes. About two third of the respondents agreed to the statement that strong regulatory uncertainty exists and nearly half said that they are able to cope well with this uncertainty. The majority disagreed that regulatory uncertainty would lead to reduced investments, but about 27% agreed, which is still a worrying fact. A similar pattern resulted for altered investments, i.e., that regulatory uncertainty leads to a change of investments. This change could be investing in small and more flexible generation projects instead of large and inflexible ones due to regulatory uncertainty. In terms of nonmarket capabilities, the majority of respondents acknowledged their ability to shape policies or influence regulatory decisions, though a minority of 15% stated they would not be capable of even shaping regulatory institutions that affect them. In an econometric analysis hypotheses were made about the setup of each nonmarket capability, i.e., which resources or capabilities are required in its establishing process. Further, hypotheses were developed on how nonmarket capabilities influence investment decisions or the effectiveness of organizational capabilities. The results of the econometric analysis validate the assumed impact on the analyzed investment decisions. First, in the case of potential future investment as stated by the firms in the Platts' PowerVision database all three defined nonmarket capabilities showed significance. Second, in the case of altered investment some significance could be detected. Third, only little significance was found for the case of actually reduced investments. Consequently, the initial argument that nonmarket capabilities allow firms to cope better with regulatory uncertainty and that firms are thus less likely to withhold investments could be proved for the case of potential future investment. Though, the connection could not be sufficiently proved between nonmarket capabilities and actually reduced investment. Further, the impact of nonmarket capabilities on organizational capabilities to exploit business opportunities that result from regulatory changes and rapid organizational adaptation has been analyzed. Particularly the nonmarket capability to influence policies or to regulatory decisions has shown a significant impact. Firms that are able to influence their nonmarket environment are also able to react faster and more adequately in their own organization. Analogously, these firms will also be able to seize business opportunities that result from regulatory changes. Organizational capabilities thus allow firms to secure their sustainable competitive advantage. Based on the results, the thesis closes with recommendations for business strategy.