REGULATORY CAPTURE: A REVIEW

Author(s): ERNESTO DAL BÓ

Source: Oxford Review of Economic Policy , Summer 2006, Vol. 22, No. 2, REGULATION
(Summer 2006), pp. 203-225
Published by: Oxford University Press

Stable URL: https://www.jstor.org/stable/23606888

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2
DOI: 10.1093/oxrep/grj013

REGULATORY CAPTURE: A REVIEW

ERNESTO DAL BO

Haas School of Business and Travers Department of Political Science, University of

Berkeley1

This article reviews both the theoretical and empirical literatures on regulatory capture. The scope is broad,
but utility regulation is emphasized. I begin by describing the Stigler-Peltzman approach to the economics of
regulation. I then open the black box of influence and regulatory discretion using a three-tier hierarchical
agency model under asymmetric information (in the spirit of Laffont and Tiróle, 1993). I discuss alternative
modelling approaches with a view to a richer set of positive predictions, including models of common agency,
revolving doors, informational lobbying, coercive pressure, and influence over committees. I discuss empirical
work involving capture and regulatory outcomes. I also review evidence on the revolving-door phenomenon
and on the impact that different methods for selecting regulators appear to have on regulatory outcomes. The
last section contains open questions for future research.

I. INTRODUCTION capture is the process through which special inter

ests affect state intervention in any of its forms,
The economics profession has devoted substantial which can include areas as diverse as the setting of
effort to answering two broad questions. First, whythe choice of foreign or monetary policy, or
taxes,
do we observe state intervention in economic life? the legislation affecting R&D. According to the
And second, what are the politico-economic proc narrow interpretation, regulatory capture is specifi
esses that shape state intervention? In a broad cally the process through which regulated monopo
sense, regulation encompasses all forms of state lies end up manipulating the state agencies that are
intervention in the economy, although a more nar supposed to control them.
row definition concerns the control of natural mo
nopolies. Thus, the term 'regulatory capture' also Most of the literature that is explicitly concerned
receives both a broad and a narrow interpretation. with regulatory capture has been developed in the
According to the broad interpretation, regulatory context of utility regulation, although a literature on

1 E-mail address: dalbo@haas.berkeley.edu

I am grateful to Dieter Helm, two anonymous referees, Clare Leaver, Martin Rossi, and Justin Tumlinson for useful comments
and suggestions.

Oxford Review of Economic Policy vol. 22 no. 2 2006

© The Author (2006). Published by Oxford University Press. All rights reserved. 203

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

political influence has grown alongside it. The domi further are the precise nature of influence and the
nant normative argument for the regulation of utiliorigin of regulatory discretion. Section III presents
ties posits that natural monopoly situations call for aa three-tier principal-agent model where influence
sole firm. Then regulation is needed to prevent thatand regulatory discretion are linked to the exchange
firm from exploiting its market power (Demsetz
of favours and asymmetric information. This theory
has a strong normative component. We briefly
(1968) challenged this view; see Berg and Tschirhart
(1988) for a clear exposition of the economics ofdiscuss the alternative 'common agency' approach.
natural monopolies, and Joskow (2005) for a more Both approaches emphasize influence through in
complete explanation of the normative argument). centives that can be construed as bribes, such as
Highly complementary to this argument is the viewdirect payments or lucrative post-agency employ
that regulators will be motivated by the duty to ment, and model regulators as a single actor. In
protect consumers from monopolistic abuse. This section IVI discuss alternatives to influence through
perspective on regulatory motivation came to be bribes, such as the provision of information and
known as the 'public interest' view (see, for in coercion, and briefly review work studying influ
stance, McCraw (1975) for an exposition). Eventu ence over collective bodies. Section V discusses
ally, observers of regulation came to challenge this
models on the 'revolving door' phenomenon, which
perspective. Even when a regulatory body has been involves a tendency of regulators to favour industry
set up to prevent monopolistic abuse, regulationwhen they have an industry background or when
ends up being 'captured' by the firms it is supposedthey expect rewards in the form of future industry
to discipline. This view was articulated in an influenemployment.
tial paper by Stigler (1971), and since then it has
been refined and expanded in a variety of ways. Section VI switches attention to empirics. First, I
discuss the scarce evidence on the effects of asym
The purpose of this review is twofold: first, tometric information (or the lack of transparency).
Then I review evidence of a connection between
provide a technically accessible account of the main
theoretical views on regulatory capture held bycapture and regulatory outcomes; I survey empiri
academic economists, and, second, to provide ancal studies on the revolving-door phenomenon and
overview of available evidence on causes and conon the potential role of regulators' personal charac
sequences of capture. The scope of this review is
teristics. Lastly, I review evidence that regulatory
broad although contributions focusing on utility reguoutcomes may respond to the methods used to
lation are emphasized. Some of the work on capture select officials who have an impact on regulation,
overlaps with the literature on corruption. We touchsuch as regulators and judges. Section VII provides
on the latter when connected to the problem of thea summary and highlights open questions for future
purchase of official favours, but abstract from thatinvestigation.
part of the corruption literature dealing with harass
ment or extortion by public officials.
II. A SIMPLE MODEL OF
This review is structured as follows. The next REGULATORY CAPTURE
section discusses briefly the argument on regulatory
capture put forward by Stigler (1971) and the(i) Stigler's Approach
formalization of these ideas by Peltzman (1976).
This initial theory of regulatory capture is, in fact, Stigler (1971) advocated an economic theory of
common to other areas of public policy and, like how the regulation of business comes to be. This
many of the theory's developments, it may beincluded, but was not limited to, the regulation o
applied to the problem of political influence as it ismonopolies. Stigler's starting point was the obser
broadly understood. Peltzman (1976) made progressvation that, as a rule, regulation is acquired by the
by leaving a number of elements in a black box. Inindustry and is designed and operated primarily for
other words, important links in the theory's logical its benefit. An additional piece of data was that
chain are assumed to work in a particular way,regulation is not only observed in association with
without our knowing whether those assumptions are natural monopolies, for which a normative rationale
reliable. Two elements that deserve to be probed exists. Many other economic activities attract state

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 E. Dal Bó

intervention, in the form of price-fixing and entryaverage haul is shorter would be associated
control. In order to account for these observations,
with stronger demand for restrictive limits by
an economic theory of regulation had to specify therailroads.
determinants of the supply and demand for regula
(iii) States with better-quality roads would have
tion. The demand for regulation would be connected
primarily to two features of the group of beneficiar less of a reason to worry about truck weight, so
that
ies. First, whether the beneficiary group is large and, the friends of railroad interests would have
second, whether the group has large stakes in
a harder time making the case that weight limits
regulation. Excessive group size could hamper sucwere urgently needed to keep roads usable.
cessful organization of the beneficiary group. Such
organization requires the resolution of the well
Stigler measured the degree of regulatory favours to
known collective-action problem. This problem arises
railroads by looking at the weight limits on four- and
six-wheel trucks by 1932-3 in each state. The
from the temptation that each potential beneficiary
explanatory variables corresponding to the argu
has to shirk his obligations in the common lobbying
effort. (This echoes Olson's (1965) view thatments
large in points (i)—(iii) were, respectively: the number
of farm trucks per 1,000 labour-force members (by
group sizes can hinder collective action.) Large stakes
could mobilize group members and give them an the average haul ofrailroad freight (by 1930);
1930);
and
incentive to demand regulation. On the supply side, the percentage of state roads of high-type (a
one
would have to pay attention to the machineryhigher-quality
that paved surface) by 1930. All three
produces regulation: the public sector, which explanatory
re variables appeared significant in the
sponds to political pressures. Stigler viewed politi
cross-state regressions (except for high-type surface
on the six-wheel trucks weight-limit regression).
cians as potential suppliers of regulation who pursue
selfish objectives, among which one should count
It is worth noting that Stigler's ideas were neither
the desire to augment their power. If power depends
both on money and votes, the costs of regulation typical at the time they were published, nor wholly
without
could include its potential to bring unpopularity to the precedent. The idea that economic policy
may not stem from a benevolent planner (as in the
politician that promotes it. However, Stigler counted
public-interest
one factor that could mitigate this cost: the fact that view) was not as well established in
the very many voters that are only marginally the mainstream economics literature as it is today.2
The
affected by regulation would have poor incentives toStiglerian approach has been related to the
be well informed about the regulation in question.
Chicago view ofpublic policy, even when it could be
seen as complementary to the emerging literature
Stigler illustrates his way of thinking throughon public
a choice, which was, in turn, associated
with the names of Buchanan, Tullock, and the
simple study of the regulation of trucks in the United
States. By the late 1920s, trucks emergedVirginia
as a school. This literature focused on the role of
political institutions in affecting collective decision
competitor to railroads on inter-city freight. Railroads
making
responded by influencing public authorities to im in the face of heterogeneous societal inter
pose limits on the weight trucks could carry in ests.
interThe view of public policy emerging from the
Stiglerian and the public-choice school emphasized
city hauls. Stigler listed various factors that should
affect the demand for regulation. the idea that regulators could be swayed by special
interests. This idea had an impact on a larger
ongoing debate on the optimal size and scope of
(i) In states with numerous farm trucks, railroads
government.
would have a harder time overcoming the agricul On the microeconomics side, insights
due to Pigou and Samuelson justified state interven
tural interests that relied on truck services, making
weight limits less likely, or less stringent. tion: in the presence of externalities or public goods,
the decentralized allocations determined by markets
(ii) Trucks posed less of a threat on long-haul
with private property will be inefficient.3 It was at
freights than on short-haul. So, states wherethat
the stage that Stigler's call for an economic theory
2 This was so even when libertarian and Marxist mistrust for state-sponsored goals was far from new.
3 A counterpoint was offered on the macroeconomic side. The monetarist school was beginning to upset the prevaili
of the macroeconomy as a system in need of activist intervention.

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

of regulation was made. If regulators are the nexus and demand information is captured in the function
of a set of special-interest pressures, should we call jt =/( p,c), where c = c(q) are the production costs
for even larger state controls in the hope of neutral of firms. Assume^ > 0,fpp < 0/c < 0.
izing the potential special-interest bias? Or should
we roll back existing regulation and live with market The politician then chooses the price he will allow
failures? A lot of the work in economics in the producers in order to maximize his majority M(p, Jt)
following decades can be organized in terms of the
subject to the constraint Jt =/(p, c). Or,
position taken regarding these questions, and we
can view Stigler's proposed programme as an im MaxM[p,f(p,c)].
p
portant step towards answering them.
The first-order condition for this problem is
As indicated by Posner (1974), a problem with
Stigler' s approach was the lack of clear implications Mp + Mn^- = 0=> M
as to the profile of groups benefited by regulation. dp dp
Stigler emphasized that industries with concen For a firm facing n
trated ownership would have an easier time at than monopolistic
overcoming the hurdles facing collective action.creases profits (
However, large groups could attract favourable assumptions M <
regulation by vote-seeking politicians. What consid
condition then tells u
eration should prevail to define the profile of regu
monopolistic pricing
lated industries? official will lower th
until the marginal
(ii) Peltzman's Model power loss from diss
starting from a com
Peltzman (1976) refined and expanded Stigler's raise the price to p
ideas. He offered three distinct formal set-ups, the where the margin
second of which focuses on price-entry regulation. industry equals the m
This model rationalizes intervention in industries that This effect will also
have both small and large numbers of beneficiaries. when prices are fix
It is this second set-up that is of interest here. tive prices. (In such
above can be seen t
The model comprises three classes of players: a entire industry, rath
politician who holds the coercive power of the state,
an undefined quantity of producers, and an unde The model predicts
fined quantity of consumers. The politician wants to entail less than 100 p
maximize his 'majority' or 'power' as given by M= also less than perf
M(p,7t), where p is the price paid by consumers and against market po
k is the profits for producers. Assume that the usually lie between
politician's majority decreases with higher prices to levels. Moreover, in
consumers (high prices are vote losers), but that it appear highest when
increases with the profits of producers (presumably perfectly competit
because those producers vote, but also because power gains from m
they can mobilize voters or other elements of the range are highest (t
community through their financial power). Both the assumptions on the
power-losing effects of higher prices and the power monopolies such as
increasing role of profits are assumed to be of but not for the no
marginally decreasing intensity. Formally, these cepted, but because
assumptions on the majority M(p,ri) take the form: that trades moderat
Mp < 0,M > 0,Mpp < < 0. Assume also that the for a large political
marginal effects of prices are unchanged by the case, and as long as t
level of profits and vice versa: M = 0. All supply reposition of capital,

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 E. Dal Bó

beneficial for social welfare (understood as profits

reader may think that a similar structure can be use
plus consumer surplus). The reverse of the pictureto think of a hierarchy featuring citizens, gover
of entrepreneurial regulatory intervention is that and the firm). The extra player (the regulato
ment,
competitive industries will attract regulation as allows
well, one to analyse how the political principa
because the initial marginal losses of power owing
might want to respond to the risk that its delegate
to angry consumers can be small relative to the may
gains be captured.
owing to grateful producers. Examples of the latter
type of regulatory presence are when the state
Tirole (1986) was probably the first to analy
engages in price fixing in competitive industries and
regulatory capture in a three-tier set-up. As I w
when it controls entry (through licensures) in occu
present it, the model has two building blocks. T
pations. The model can then account for the firstapparis the model of regulation of a monopolist wi
ent puzzle of regulation being present in technologic
unknown marginal costs (Baron and Myerson, 1982)
ally diverse industries. In this set-up, the firm has private information on
costs. Thus, the government is unsure about ho
The main feature in Peltzman's model is that muchthe of a cost reimbursement (or how high a price
the firm should be allowed. The optimal best r
official appears to be trading off the benefits from
favouring two different masters: consumers and for the regulator is to offer a second-be
sponse
producers. However, little is said about how those
contract to the firm, one that attempts to limit th
benefits materialize. Neither of the two stakeholders
benefit the firm derives from the asymmetric inf
in the model is explicitly considered an active,
mation. However, because the firm is valuable
strategic player. Moreover, no detail is given consumers
as to even when costs are high, and becau
how a politician can equally depart from monopolis
costs are high with some probability, the contra
tic or competitive pricing. In the case of a natural
offered to a firm when the government does n
monopoly, for instance, a regulator may be limited
know the state of nature necessarily leaves the firm
by the fact that he is supposed to leave the firm
somearents in situations when costs are actually low
reasonable rate of return, but allowing for higher
The second building block, as proposed by Tiro
prices may be denounced as a give-away to indus
(1986), then further developed by Laffont and Tiro
(1993, ch. 11), assumes that the regulator, w
try. The following section covers models tackling
these limitations. specializes in learning about the industry, may find
out the true costs of the firm. Then the firm has an
incentive to bribe the regulator into not telling the
III. PRIVATE INFORMATION AND government when costs are low. If the regulato
COLLUSION IN HIERARCHICAL says he has learned nothing, the best possible co
AGENCY tract that the government can offer the firm is on
that leaves rents to the firm. The government then

(i) Overview has an incentive to offer the regulator a contra

inducing him not to lie and simultaneously to offer
contract
One way to understand capture is by thinking oftoa the firm that reduces incentives for
collusion with the regulator.
three-tier hierarchy comprising a political principal
(the government), a regulator, and an agent (the
firm). Why use a principal-agent model? This is the
(ii) The Model
set-up used when we want to analyse incentive
problems in detail. The simplest possible model
In this set-up, the firm has private information about
the marginal cost of providing a service to consum
would have only two parties: a firm and a (potentially
ers, and the government wants to maximize an
capturable) government. Can we justify complicat
objective
ing the model by considering more players? The including consumer surplus.4 In keeping
introduction of a third element allows differentiation
with the notation of last section, the firm's operating
profits
between the government and the regulator (the are 7t( p) = q (p) p - C (q (p)), where q (p)

4 Spiller (1990) analyses a related problem where Congress lacks information on the regulator's amount of effort di
improving regulatory outcomes.

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

is the demand function,/? is the allowed price, and C in high-cost situations, so that lower demanded
= F + qc is the cost of provision, where F is a fixedquantities will reduce the informational rent. The
cost. The marginal cost c takes one of two values inproblem with this is that it reduces consumer surplus
the set {Cj, cj, where Q<c< ch. Marginal costs are when costs are high. Hence, the trade-off facing the
determined by unpredictable developments that are government can be characterized as being between
beyond the players' control, such as oil discoveries,lowering informational rents in low-cost situations
weather changes, etc. So, we will say they are and not reducing consumer surplus in high-cost
determined by' nature'. Nature picks low costs with situations. There are many potential arrangements
probability yand high costs with probability 1 -y. In the government could choose from. However, the
addition to approving a price, the government hasgovernment loses nothing by restricting itself to
the ability to make transfers Tto the firm, which are imposing arrangements that are tailored to each
paid for by consumers. The total pay-off for the firmtype, while respecting the condition that each type
is n = n(p) + T. The pay-off for consumers is their should have incentives not to misrepresent its pri
consumer surplus minus their tax payments to fi vate information.5 Therefore, whatever arrange
nance transfers to the firm (we assume the government the government offers must entail,
ment keeps a balanced budget; the taxes paid by
consumers equal the transfers to the firm). The n>(p„T) > n <(ph,Th),
government seeks to maximize social welfare as
given by which is called the incentive compatibility constraint
of the low-cost firm. Analogously (although not
S = sip) - T. binding in equilibrium), the offered arrangement
must give the high-cost firm incentives for sincerity,
Hence, the government would like to use transfers i.e. nh(ph,Th) > Hh(ppT¡). Simultaneously, the par
to reimburse the firm just for its fixed cost and set ticipation constraint on the two types of firm is that
prices equal to marginal cost in order to maximize the government must offer terms that will not induce
net surplus. When the government knows the reali any type to shut down: YV{ppT) > 0,1~lh(ph, Th). In
zation of c, such an arrangement is feasible. But it fact, the government will offer the following ar
is not when the government does not know the rangement,
realization of c. Suppose for a second that the
government has offered the full information con Uh =0;n' =q(p*h)Ac
tracts {[T=F,p=cl], [T=F,pf=ch]}. Then even y *
when costs are low the firm has an incentive to claim Ph = ch+~—Ac
l-y
that costs are high and obtain better compensation.
The informational rent the low-cost firm would Pi =c¡.
obtain in the asymmetric information regime is
A sketch of the proof is in the Appendix.
H' = q(P,)(Ph ~ c) = q(ph)(ph - ch) + q(ph)(ch - observations
c) are worth making. First, in orde
= q(ph)(ch - c) = q(ph)^c, reduce the informational rent that the firm get
low states, the government raises the price in
where Ac = ch -cr Clearly, q (ph)Ac > 0, and thecost states by (y/(l - y))Ac (which reduce
low-cost firm obtains a positive rent owing to its
manded quantities and thus the informational
informational superiority. q(p*)Ac). Note that the government raises ph
ther when y is high, so the expected benefit
The government can do better than simply offer the reduced informational rent is high, and the expe
full information contracts and have firms obtain ancost of a reduction in consumer surplus is sm
informational rent whenever costs are low. One Second, marginal cost pricing is preserved in the
way of doing this is to raise the price that is allowed
cost state and no rents are left to the high-cost f

5 The revelation principle (Myerson, 1979) implies that the optimization over all possible arrangements
where the player with private information simply reveals its type truthfully. See Laffont and Tiróle (1993,
proof in a very similar context to that presented here.
6 The solution is completed with the characterization of transfers: T: = F + q (p*)Ac ; and Th = F-q (p*

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 E. Dal Bó

The government should be interested in finding a to the regulator and the potential distor
payments
regulator who specializes in learning c in order to tryto the contract to be offered by the firm. We
tions
more often to implement first-best allocations. In
now assume that deterring collusion is worthwhile
andthe
this way the government can save on rents left to focus on the consequences for equilibrium
firm and on distortions in the high-cost state.allocations.
Sup
pose, then, that when the firm has low costs, the
regulator learns it with probability X, and learnsIfita in
regulator is colluding with the firm, he will
a way that is verifiable to the government. alwaysWithclaim to know nothing, and the probability of
a low state is simply y. Under a collusion-proof
probability 1- X the regulator finds nothing. When
costs are high, the regulator can never learn any though, the regulator behaves honestly.
contract,
So, the probability that costs are low when the
thing.7 The timing of interaction is as follows. First,
nature determines the firm's costs, and the firm regulator claims to be uninformed is
learns it. Second, the government announces both a
y(l-k) y(l-X)
p the
wage to the regulator and regulatory contracts to = P(c = c, I r = 0) =
y(l-A,) + (l-y) 1-A.y
firm, both potentially contingent on the regulator's
We assume that the government does n
report. Third, if c = cp the regulator learns it with
probability X (and the firm learns whether about the the income of regulators from a welfa
regulator learned costs or not). Fourth, the firmof
and
view, except in that it detracts from cons
the regulator decide whether to collude. Fifth, the
income. Recall that when the government
regulator sends a report to the government no r einformation, it will offer the second-best
characterized earlier, although taking into
{c,,0}. This means that the regulator, when seeing
that
that c = cp can reveal it, but can also claim to be the regulator claiming to be uninformed
the perceived probability of the low st
uninformed, both in that situation and when he really
is uninformed. After getting the report, r, wages and
second-best contract specifies marginal cost p
contracts are made available to regulator and firm.
for the low-cost firm but leaves rents in it, a
rents depend on the price chosen for the h
Note that when costs are low and the regulator
firm. No rents are left to the firm in the h
learns this is the case, a truthful report to the
situation. Then, expected social welfare, as
the
government will induce the latter to offer the lullgovernment, can be written as
information contract to the firm and not accept any
EV=yX{s
claims that costs are higher. Thus, the firm's infor (c)-F-w} +(1 -yX) {p [s (c,)-
mational rent evaporates. Hence, the firm has an - p) [s (ph, p) - Th (p)]},
+ (1
incentive to pay the regulator a bribe up to the value
of the informational rent in order to buy his silence.
where T (p) (i = l,h) denotes that transfers ar
The value of the informational rent is q{ ph )Ac.determined
It is in the second-best solution cor
ing to the case when the government has
clear that if the government wants to compete with
r = 0 and hence holds beliefs ji on the l
the firm and push the regulator towards honest
state.
reporting, a payment conditional on r=c; should be The maximization of this problem yiel
promised. Denote this payment w and assume that
Y a Y^ 1
the reservation wage of regulators is zero. Assume
Ph=ch+~ Ac" Ac.
that every dollar that the firm may offer the regula 1 - Y (1 — Y) 1 + \|/

tor in side payments costs the firm 1 + t|/. For the

Thisthe
regulator to want to report that costs are low, expression contains a familiar term, (y/(l -
wage must satisfy, y))Ac, which is the distortion introduced in the
optimal contract seen before, when a regulator was
not available. But the extra term,
1 + \|/

The benefit of preventing collusion fully is to gain full yX

1- 1 Ac
information more often. The cost is the incentive 0-Y) 1 + \|/

71 model regulatory learning as Armstrong and Sappington (2005) do. Assuming that the regulator can also become informed
in the high-cost situation complicates notation without adding insight.

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

implies that the distortion to the high-cost price when remuneration allowed by th
a regulator is available will be smaller, even if the sensitive to production costs.
regulator is corruptible. The parameter \j/ might be will want to appoint a mon
seen as a 'capture' parameter. When it is zero, the mitigate the informational
firm has no difficulty sharing the information rent with The
danger is then that th
the regulator. So, a dollar from the firm has maximum regulator not to disclose in
purchasing power. In that situation, the term reduce the approved compe
1 tors and firms may collude to
1
from consumers even when t
l+y
would justify a reduction
goes to zero, and the distortion-saving power of scope for such capture of the
having a regulator with learning capabilities disap depends on the amount of
pears. The price set for the high-cost firm con regulator may obtain, and o
verges to that when the government has no access ment makes it to bribe regul
to a regulator. When \|/ is positive, however, the
distortion savings increase. In the limit, when t|/goes
(iii) Discussion
to infinity, the regulator becomes essentially incor
ruptible because even the smallest bribe is infinitely The model just reviewed of
costly to the firm. In that case, we obtain work to understand how asym
the source of regulatory discr
Ph = ch + -^—Ac - Ac = ch + -^-(1 - X)Ac. possible. The model also c
l-Y (l-y) l-y
sponses by the political princ
The last expression indicates
affectthat, relative to
implemented the
allocatio
strike
case with no regulator, the some
distortion isreaders as perta
diminished in
proportion to the amountrather
of information brought
than positive, by
approach
that
the regulator (measured by the the offer by
probability the gove
X that he
is informed). Note that the informational
wages quality ofon
that are contingent
the regulator also affects the solution.
is implausible. In When the
the current
regulator is never informed (X = 0), things
offer contingent are
wages would
exactly as when the regulator does
ity of not exist,
combating and the
collusion.
solution reverts back to the original one. If the
regulator is always informed
The (X = 1), the has
literature savings
longon
cons
pricing distortion are maximal. Note that
to use wages the ideal
to fight captu
combination of a regulator(1974) consider
that is wages
perfectly that a
informed
and incorruptible (X = 1, \j/on
gent —> °°) regulator's
the eliminates actio
all
distortion, yielding ph = ch.
are The
higher
reason
than
is the
that
regulator
if the
regulator is effectively and make the and
incorruptible, latter eage
always
alerts the government if costs are low, with
combination the problem
above-mar
reverts back to one where the
ment government
could is the
then audit perrep
fectly informed. fire those who are found to h
firm's private information. T
At this point it may be useful to provide
regulators a brief non
of engaging in w
technical summary of the model
cious andof
choice findings. Theau
wages and
model relies on a few contribute
basic assumptions.
to mitigateThe
captu
has used
regulated firm has superior similar ideas
information aboutin co
its
production costs, and the government
deterrence wants the
and corruption con
firm to produce as much as would be convenient for
example, Becker (1968), and
consumers. The firm, however, cannot
instance, be forced
Besley to
and McLar
produce when doing so would trigger
Di Telia losses,
(1997)). so the
In real life

; On the role of external supervisors in collusive hierarch

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 E. Dal Bó

regulators
wages and monitoring to deter regulatory favours is can be thought of as single person. T
limited. The stakes are so large that, fines being
important questions are whether the provision
infeasible and monitoring being imperfect, the re
incentives is the only, or even the most relevan
quired wages would be astronomical. Thus, more
instrument of influence, and what happens when
complex institutional responses may be required.
target of influence is a collective body. This sectio
One possibility is the separation of regulatory powbegins by discussing the provision of inform
then
tion as opposed (or in addition) to incentives
ers so as to lower the stakes in collusion (Laffont
and Martimort, 1999). Another possibility is to related
level matter is that the type of incentives used
the playing field by incorporating the different
the models of section III can, broadly speaking,
understood as 'bribes'. So an additional quest
stakeholders into the bureaucratic design of regula
tory decision-making (McCubbins etal., 1987).arises as to what form of incentives can be under
stood that way, and whether other forms of incen
tives may play a role. The second part of this section
(iv) An Alternative Model that does not Rely
then discusses alternative forms of influence that do
on Private Information
not exclusively rely on the provision of incentives
that
Bernheim and Whinston (1986) introduced the' can be construed as bribes. Finally, the third part
com
mon agency' model of influence, which has a moresection briefly discusses work studying influ
of the
ence over collective bodies.
positive angle. In this set-up, multiple parties offer
'price lists' for different favours or allocations that
the official, or common agent, may set. Those
(i) Are Incentives the Only Instrument of
parties compete, offering such schedules reflecting
Influence?
the prices they are willing to pay for different policy
A literature in political science and economics has
choices, and hence this model is built upon a 'menu'
auction. This model allows a more preciseanalysed
char the provision of information, rather than
acterization of the nature of influence in situations incentives, as a form of exerting influence. Calvert
where there is competition for policy favours, as (1985) proposes a particular model of information
originally studied by Peltzman (1976) and Becker processing where the known bias of an advisor (or
(1983). In the common-agency set-up there is no interest group) cannot be fully 'undone' by the
asymmetric information, and the origin of the discre receiver of information (say, the regulator).10 This
tion of the official remains unmodelled. The model model yields that the decision-maker may in fact
features multiple equilibria which may be ineffi prefer to use biased advisors, much as when regu
cient.9 Grossman and Helpman (1994) extended the lators receive information from firms and other
common-agency model to analyse trade policy de players of the regulatory game. The benefit of
termination, while sticking with quasi-linear pay-off having a biased advisor is that it can become a more
functions. We comment later on empirical investi credible source in extreme situations where a mis
gations inspired by this model. Dixit et al. (1997) take would be particularly costly. Austen Smith and
further extended the common agency set-up to Wright (1992) offer a model where there are two,
consider general pay-off functions, which allows us rather than one, sources of information. In their set
to analyse situations where income effects matter. up, two interest groups may make costly searches
for information and then offer messages to a deci
sion-maker. Although the model is intended to cap
IV. ON THE INSTRUMENTS AND ture informational lobbying to win over a legislator,
TARGETS OF INFLUENCE the set-up can help explain situations when firms
and consumer advocates offer information to try to
affect
The capture models reviewed so far assume a regulator's decision. For example, these
that
firms will provide incentives to regulators, stakeholders
and that may commission costly consultants to

9 Equilibria that are 'truthful' are also efficient. Truthful equilibria involve truthful strategies in that the schedules of prices offered
by interest groups must reflect the shape of those groups' pay-off functions. This class of equilibria coincides with the set of
coalition-proof equilibria.
10 The bias does not merely affect the expected levels of advice, but also the shape of the probability distribution over possible
advice messages.

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

provide industry-specific studies. In this model, Telia (2003) for some examples). Firms may per
messages need not be truthful, but the regulator has haps more often be able to spread negative rumours
the possibility, at a cost, of verifying the informationabout the competence of a regulator, which may
he has received (possibly by commissioning further damage the latter's career. Also, they may destabilize
consulting). For some parameter values it is shown a regulator's grip on his job by open confrontation,
that none, one, or both interest groups may acquire which may raise the political costs for government
information with positive probability and then submitof backing up the regulator. Indeed, Hilton (1972)
messages to the regulator. Moreover, there areargued that in real life the main objective of regula
regions of the parameter space where the regulatortors is to minimize complaints by firms, or keeping
ends up making perfect decisions. regulated firms from 'squawking'. However, when
it is known that regulators may be influenced through
Lohmann (1993) tackles the (very different) ques potential complaints from firms, the observation of
tion of whether mass political action can convey such behaviour may simply indicate that the regula
information. This set-up is different from the previ tor is performing his duties well. Thus, the power of
ous ones in that signalling is costly. In her model,squawk to damage the regulator is not a logically
engaging in the activity that may ultimately convey foregone conclusion. Leaver (2002) offers a model
information is costly in itself; in other words, the costwhere regulators may take more or less aggressive
is the message. Although the connection with regustances toward firms, and both positions may be
lation is tenuous, the basic message of her model isright or wrong depending on the state of nature (say,
useful: by engaging in costly actions (such as com cost levels facing the firm). Because regulators do
missioning consulting that may be in itself irrelevant) not exactly know the state of nature, they may make
an interest group such as the firm may signal its mistakes and hurt firms unnecessarily. Regulators
private information about the appropriateness of acome in two types: smart and dumb. The latter are
particular policy. more likely to make mistakes, and the market will
learn about mistakes when firms squawk. When
regulators' concerns about reputation are strong,
(ii) What are the Incentives Provided by
there is a Bayesian perfect equilibrium where two
Industry?
things happen: firms complain against mistaken
As suggested by the model reviewed in section III, tough policies, but not against generous ones (even
one possibility is for firms to offer outright bribes. if mistaken). Less able regulators, fearing that firm
Another possibility is money payments with political complaints may damage their reputation, are gener
use, such as campaign contributions to politicians ous to the firm some of the time, even when having
with electoral goals. In the case of regulators with information indicating that a tough policy is called
out electoral ambitions, a much talked about form of for. The overall message is that the possibility that
incentive is the promise, tacit or explicit, of future firms may complain publicly about tough regulatory
lucrative employment in industry. The twin facts decisions buys firms some regulatory slack.
that regulators have often had industry jobs before,
and sometimes end up in industry after their tenure, The incentive-based models reviewed so far as
is referred to as the 'revolving doors' phenomenon. sume that a special interest such as the regulated
In section VI discuss some theoretical contributions firm will use either bribes or some form of coercive
regarding this phenomenon and I review evidence inducement. However, there is no reason to sup
about it in section VI. pose that firms will restrict themselves to using only
positive or only negative incentives to influence
Another possibility is that firms may attempt to regulators, if both instruments are available. Dal Bó
influence regulators through negative incentives, et al. (2006) offer a model where an interest group
such as threats, tacit or explicit, of lowering their offers both bribes and threats to officials in its
utility. This could be attained through direct physical attempts to influence public policy. Three main
punishment. Although perhaps not so relevant for implications follow from this model.
economies where the rule of law is well established,
this form of incentive to officials is more widespread (i) When firms have a way of imposing disutility
in some emerging economies (see Dal Bó and Di on regulators, they will save on rewards by

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 E. Dal Bó

simultaneously threateningpotential retaliations,

to legislators who are not 'friendly' enough to vote
private or political, against the regulator. for the principal's project, but who are at the same
time not unfriendly enough to become too expen
(ii) Relative to a world in which firms cannot exert
sive. At the same time, the outside interest will limit
what
coercive pressure, the pay-off to regulators is it asks for in order to lower the costs of
lower. Ifpay-offs determine competence, influence.
com In his model, passing a bill will typically
petence in regulation will be lower when coer
require bribing entire blocks of legislators, suggest
cive pressure is feasible. ing that influencing larger bodies will be typically
more expensive. Neeman (1999) studies a multi
(iii) When retaliations are feasible the cost of influ
agent contracting problem under uncertainty and
ence is smaller. Hence, even when the gain in
applies it to voting. He shows that in very large
profits from a price favour may not be as large,
voting bodies a member will attach a small probabil
influence may be affordable. ity to being pivotal and sell her vote cheap. Dal Bó
(2000) seeks to unveil vulnerabilities of collective
Therefore, regulatory capture may be more preva
bodies to outside influence that will operate even
lent in countries where regulators are less protected
under certainty, and then studies potential remedies.
from violence or from firm-originated rumours,Heasconsiders the possibility that a lobby may make
would be the case when the rule of law is weakeroffers
or that are not only contingent on the way an
when regulatory job stability is lower. If the term
individual committee member acts, but also on the
way other members do. This flexibility tends to
length of regulatory positions is a proxy for relative
stability, one would expect longer-term regulators to a lobby acting unopposed to capture commit
allow
feel more insulated against firm retaliations that
tees of any size at no cost. The main protections
against this vulnerability are committee members
damage the market value of regulator's reputations.
The section on empirics presents evidence onthat thecan enforce cooperation among themselves,
connection between term lengths and regulatory committee members that are accountable to outside
outcomes. Implications (ii) and (iii) together imply
parties, or secret voting.
that countries with more prevalent capture will have
less competent regulators. Bennedsen and Feldmann (2002) extend the litera
ture on informational lobbying to the case where the

(iii) Influence over Collective Bodies target is not an individual but a collective body, such
as a legislature. In their model, an interest group
The literature on influence over collective bodies is wants a particular public good provided (say, envi
relevant for regulation both when regulatory agen ronmental protection). The legislature is made up of
cies are run by boards and when legislatures affect representatives coming from districts that have
regulatory policy. This literature has been mainly different valuations for the public good. They show
associated with concerns about the capture ofthat a lobby may have an incentive to generate
legislators. Denzau and Munger (1986) attack the information on what districts would benefit the most
problem by focusing on a single legislator who faces from the public good. This information will allow an
a problem analogous to that studied by Peltzman agenda-setter a more finely tuned coalition-building
(1976): on the one hand, a special interest may offer strategy that relies on high-valuation districts. This
rewards such as campaign contributions, but on the minimum-cost coalition made ofhigh-valuation dis
other, constituents may punish a legislator who sells tricts leads to the approval of higher levels of the
out. The authors then indicate that a special interest public good desired by the lobby. When party cohe
will typically face legislators with varying 'prices', sion is very strong in a legislature and legislators vote
and that the purchaser of legislative favours will try in large blocks, the heterogeneity of districts cannot
to assemble a majority of minimum-cost legislators. be easily exploited by an agenda-setter seeking to
Snyder (1991) was probably the first fully to model form a minimum-cost coalition. Thus, party cohe
the vote-purchasing decision of an outsider while sion in parliamentary democracies (as in Europe)
considering a multi-member legislature. In equilib dilutes the incentives to direct informational lobby
rium, an optimizing principal will direct its resources ing efforts at legislators. As a result, informational

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

lobbying should target regulatory bodies more heav employees that seem to have industry interests
ily in countries displaying high party cohesion in more at heart. Then, regulators may try to signal
legislatures. their appeal to industry by being lenient to it. In this
last situation, a pro-industry regulatory bias is more
of an instance of the 'collateral damage' of a free
V. REVOLVING DOORS circulation of human capital.

The set-ups explored so far illuminate a way in

The fact that many regulators come from industry,
or end up there, has long been thought to be a which
source posterior employment in industry may affect
of bias in regulatory decisions. In keeping withregulatory
the decisions: such a possibility acts like a
covert bribe and induces lenient decisions toward
rest of the paper, this section uses a 'public utility'
lens, but the topic of the revolving doors is industry.
more Having explored models in sections II and
III that can help rationalize the negative side of the
general and the models reviewed here can certainly
revolving
be thought to have implications for other areas of doors, I now review more optimistic views.
The
regulation. For example, defence procurement offiremainder of this section explains in detail the
cials may go to work in the defence industry,
arguments in two papers pushing the view that the
revolving doors may not only allow industry a larger
government health policy-makers may eventually
pool ofhuman capital; the revolving doors may even
take jobs with private health companies, tax officials
may become corporate tax advisers, etc. The induce
list of better regulatory outcomes.
possible moves from the public to the private sector
(and vice versa) is, indeed, long. The first of these two papers is by Che (1995). He
considers a hierarchical agency model ä la Tiróle
(1986) and provides three different treatments. In
The channels through which industry employment
theAn
may affect regulatory performance are multiple. first, it is assumed that regulators may invest in
human
important distinction is whether such employment is capital during their tenure. Two forms of
capital are available: 'technical' capital, or exper
held before or after regulatory involvement. Coming
tise,
from industry may induce regulators to make proand 'lobbying' capital, or contacts. The first
type of capital reduces the marginal cost of monitor
industry decisions because of the regulator having
ing
been' socialized' in an industry environment. This inthe firm, while the second does not. When
industry
turn may yield different cases. In one extreme, we future employment is associated to firms
wanting to obtain technical expertise, then regu
might find fairly irreflexive, partisan pro-industry
types; on the other, well-meaning individuals lators
who will want to obtain such expertise. This will
tend to see the concerns of industry as morein turn lower a regulator' s costs of monitoring the
legiti
mate, salient, or relevant to general welfare,firm.
be Under the optimal contract placed by the
overall principal (the government, say), this lower
cause those are the concerns they are most familiar
with. An example of the latter case might be of
cost a monitoring translates into better regulatory
person with industry background who worries outcomes
about and lower informational rents left to the
firm. Thus, opening the revolving doors would in
the fact that low prices may discourage investment,
this case encourage the acquisition of useful
and in turn hurt future consumers.11 The possibility
expertise by regulators. However, if firms em
of post-regulatory employment is different: regula
ploy former regulators because of their contacts
tors may bias their decisions in order to enhance
their chance of future employment in industry.
andAn
potential lobbying usefulness, then opening the
revolving doors may have the opposite effect,
explicit quid pro quo may exist, whereby lenient
namely
regulation is rewarded with future employment in that of discouraging the acquisition of
industry. At other times, firms may mainly
useful
hire expertise. An important empirical question
former regulators because the latter possessis valu
then what is the primary drive behind firms
able skills and not because such hiring is part of a
employing former regulators: expertise or lobby
ing potential?
reward scheme. Still, given skills, firms may prefer

11 Thus, one could argue that very harsh regulation may reduce investment and affect capacity to serve future consumers. Navarro
(1982) studies the cost of capital and the rankings of Public Utility Commissions (PUCs) from the point of view of stockholders.
Firms under the watch of harsh PUCs appear to face higher cost of capital.

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 E. Dal Bó

A second treatment in Che (1995) considers the 'cooperate': firms invest, and regulators
players
possibility that regulators may want to be aggressive
allow for capital recovery. In real life, however, no
in order to signal their intellectual quality. More able is infinitely lived, but rather made up of
player
individuals, when acting as regulators, will more
subsequent generations of players. When genera
often obtain information about the firm that can be of regulators and firms overlap (with young
tions
used to justify harsher regulation. When firms regulators
want facing old firm managers and vice versa),
to employ more able individuals, and ability is notdegree of cooperation is possible, even if each
some
readily observable, the firm may want to employ
generation is finitely lived (see also Cremer, 1986).
former regulators that were harsh because thisSalant (1995) shows that the amount of cooperation
provides a positive indication of ability. A crucial
between overlapping generations of regulators and
assumption here is that regulators cannot separate
firms can be enhanced by the revolving door. The
their manifestations of intellectual fire-power from
possibility of future consulting income 'on the other
side of the fence', depends on players having be
their use of discretion. In real life, a regulator may
be able to convey both great intellectual qualifica
haved cooperatively during their tenures as manag
tions and a disposition towards leniency. Also,
ers in
and regulators. This endows the ongoing rela
complex situations, such as those surrounding tariff
tionship between firms and regulators with an extra
reviews, a person may convey great intellectual
instrument to punish noncooperative behaviour, and
thus
ability by finding apparently good arguments that allows the system to sustain investment and
get
the firm to more favourable ground. capital recovery. One important associated risk of
the revolving doors in this model is that it gives
players 'too much' of an incentive to cooperate, in
The third treatment by Che (1995) is when he allows
for explicit collusion between the firm and the
thesense that they would find it worthwhile to over
accumulate capacity. Projects that are not benefi
regulator. The key assumption is that such collusion
may not always succeed. As we saw in section cialIII,
to consumers can be sustained in equilibrium.
collusion happens because the regulator may shield
An important assumption behind the result that the
revolving
the firm from the tightest regulatory policy that the doors cannot damage welfare is that
projects
state of nature justifies. For the regulator to find out not satisfying a break-even constraint will
not be approved.
about whether the firm has a stake in hiding informa
tion, the regulator must monitor the firm. Thus, more
intense monitoring by the regulator increases the
chance that the latter will sign a profitable VI.
sideEVIDENCE
contract with the firm. Open revolving doors can be
seen to facilitate such transactions by giving the The
firmevidence on the determinants of regulatory
a currency with which to buy off the regulator.
capture is still well short of abundant. Evidence
Therefore, revolving doors increase the regulator's
involving corruption at the national level was estab
incentives to monitor the firm. But because some of lished relatively early, and studies have shown that
the time collusion fails, the extra monitoring some lack of market competition and closeness to trade
times translates into better regulatory outcomes. are determinants of corruption (see, for instance
Ades and Di Telia, 1999). The related questions at
The second paper offering a revisionist view on the the regulatory agency level, such as whether regu
revolving doors is by Salant (1995). His focus is on lators with overlapping jurisdictions or budgets tied
the classic hold-up problem facing a party that has to outcomes fare better or worse, have, to my
sunk a relationship-specific investment. Suppose knowledge, not been tackled by empirical research
the regulated firm has invested to create production The emphasis of theory on asymmetric information
capacity. Regulators that aim at maximizing con and on the use of wages as a capture deterrent also
sumer surplus may then push down prices so much seem unmatched by empirical research. An excep
as to expropriate the firm's sunk investment, instead tion is Di Telia and Schargrodsky (2003), who
of allowing for capital recovery. Foreseeing this, investigate the use of wages and monitoring in
firms will under-invest. In a game where both the hospital procurement. Reinikka and Svensson (2005
firm and the regulator are infinitely lived, there is a also find that more information through a newspaper
(sub-game perfect Nash) equilibrium where both campaign in Uganda gave schools more of a chance

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

to claim funds to which they were entitled, reducing gerial shirking and lobbying instead of effort exer
the probability that the funds would be captured by tion, and the way to meet service obligation targets
local officials. Also, some work has been done on is to use more inputs per unit of output. Dal Bó and
the role of transparency in inducing fiscal responsi Rossi (2004) study a panel of 80 electricity distribu
bility. Lowry and Alt (2001) offer a model and tion firms in 13 Latin American countries for the
evidence that more-restrictive fiscal institutions may period 1994—2001. They find that firms are more
enhance transparency by allowing investors to ex inefficient in countries and times displaying higher
tract better signals regarding the government's corruption.
fiscal responsibility. Alt and Lassen (2006) use
survey data on the perceived transparency of budg Another way of analysing the connection between
etary information for OECD countries and find that capture and outcomes is looking at whether influ
lower-transparency countries have a political fiscal ence in the form of campaign contributions to
cycle, while high-transparency countries do not. politicians matters. Because the focus of this article
Apart from this relatively scant evidence on the role is on regulation, I do not cover the large literature
of transparency, none of which is related to indus studying whether campaign contributions affect
trial or utility regulation, there is virtually no evidence dimensions of legislative behaviour such as roll-call
of how (or whether) asymmetric information fos voting. Rather, I comment on the (unfortunately
ters regulatory capture. scarce) evidence regarding the link between politi
cal influence and regulatory outcomes. We may see
In the remainder of this section I review available legislators as regulators themselves, or, given, for
evidence of four types. The first pertains to the example, the Congressional oversight on regulatory
potential impact of capture on policy outcomes. The agencies, one may conjecture that campaign contri
second type specifically concerns the revolving butions to legislators may affect the inclination of the
doors. The third relates to whether regulator char latter to exert pressure over agencies.
acteristics matter. Some of this evidence comes out
in work investigating the effects of revolving doors De Figueiredo and Edwards (2005) analyse whole
and is covered then. The fourth type of evidence is sale price determination by state regulatory com
on whether regulators appear to reflect pressure missions in telecommunications. They focus on the
from citizens. To get at this issue I survey evidence price that incumbents are allowed to charge en
on whether the mechanisms to elect regulators play trants to local networks in densely populated areas.
a role. If they do, then under certain institutional set The authors have a panel of price decisions made at
ups regulators may be more accountable to citizens. the state level in the United States, corresponding to
This is important in order to ascertain the extent to three electoral cycles (1997-8, 1999-2000, and
which models such as Peltzman's are accurate when 2001-2). The main explanatory variable they con
portraying regulation as the outcome of a balance of sider is the campaign contributions to candidates to
pressures in which consumers play a role. the state legislature made by incumbent firms rela
tive to entrant ones. Although limited by the number

(i) Capture and Regulatory Outcomes of regulatory decisions, the authors find evidence
consistent with the idea that campaign contributions
Relating the amount of capture to regulatory out affect price regulatory decisions. When campaign
comes is difficult, mainly because measuring cap contributions by incumbent firms are relatively higher,
ture is tricky. One way of doing this is using so are the prices that incumbents are allowed to
nationwide measures of corruption, which may be charge entrants.
correlated to regulatory capture. Dal Bó and Rossi
(2004) test a simple model for why countries where Taking regulation in a broad sense, we may consider
regulators are more easily capturable should have trade policy as a regulatory outcome. Hansen and
more inefficient utilities. When regulators are more Park (1995) study the determinants of the
likely to be vulnerable to influence and approve price International Trade Administration (ITA) decisions
hikes, firm managers do not have incentives to try when US domestic firms report unfair practices by
their best when coordinating and supervising the use foreign competitors. In implementing US laws, the
of production factors. This will induce more mana ITA eventually faces a confrontation with foreign

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 E. Dal Bó

governments and firms, creating a cost to simply

vote in support of the broadcasting industry more
yield to domestic pressure. The authors use over a For instance, they voted to renew broadcast
often.
thousand decisions by the ITA (which may end licenses
up 88.7 per cent of the time, while other
in the granting of protection or not) between commissioners
1980 only supported that decision 69.2 per
and 1990. They find that protective decisionscent areof the time. However, Gormley also finds that
significantly associated with the industry' s Political
party allegiance matters as much, and for some
Action Committee (PAC) contributions to trade
decisions, more. Republicans tend to vote consist
oversight committee members. Further work on in the interests of industry. Thus, Gormley's
ently
trade policy has tested the predictions of Grossman
conclusion is that although industry background
and Helpman's (1994) menu auction, common
seems to matter, it is not clear that it has a very
agency model. Goldberg and Maggi (1999), Gawande
strong effect once one considers the role of political
and Bandyopadhyay (2000), and Eicher and Osang
affiliations. On a similar note, Navarro (1982) re
(2002) offer econometric studies of the determina
ports that liberal PUCs tend to create a more 'rate
tion of imports, trade protection, and lobbying ex
suppressing' climate (i.e. to bring consumer prices
penditures. They show that the pattern of non-tariff
down). Beyond the incentives connection high
protection and lobbying expenditures through indus
lighted by the capture model reviewed in section III,
try PACs contributing to legislators fits the predic
the evidence seems to indicate that the personal
tions of the Grossman and Helpman model. Sectors
characteristics of regulators, as well as the endow
with more elastic import demands are lessments
pro and capabilities of regulatory agencies, play
tected, the import penetration matters differently for
a potentially crucial role. In this connection, profes
organized and unorganized industries, and industry sionalism appears to have non-innocuous effects.
lobbies seem to contribute in accordance to the Berry (1979) presents evidence compatible with the
strength of opposing lobbies. F or instance, upstream idea that regulatory commissions enjoying higher
firms seeking protection lobby harder when their degrees of professionalism (as related to budgets
potential opposition (downstream firms) is more and recruitment policies) tend to reduce prices to
concentrated. The work studying how well theconsumers relative to large users. This is especially
Grossman and Helpman (1994) set-up fits tradethe case when the value of power consumption is
policy data tends to show that the model does a good higher and hence more salient to consumers.
job at accounting for the patterns of protection. I
believe it is noteworthy that a model that altogether Cohen (1986) revisits the issue of whether industry
abstracts from asymmetric information explainsemployment may affect decisions in the FCC, using
trade policy well. It is unclear, however, to what data from 1955 to 1974. He analyses both the
extent the inclusion of 'transparency' variablesproblem of previous and posterior industry employ
could improve explanatory power. ment. In addition, he looks at effects at different
points along agency tenure. He finds that commis

(ii) Revolving Doors and Regulators' Personal sioners with previous industry experience are more
Characteristics supportive of industry interests all along their ca
reers as regulators. As with Gormley's study, it is
difficult to tell to what extent industry background
Interest in the empirics of revolving doors emerged
really matters,
first in political science. Gormley (1979) presents a because it is highly correlated with
the party affiliation of commissioners. In fact, no
study of the voting patterns of the seven members
Democratic
of the F ederal Communications Commission (F CC) administration appointed a commis
between 1974 and 1976. He focuses on the idea that sioner with industry background during the sample
industry background may affect the behaviour ofperiod. Commissioners that take industry employ
regulators. Thus, his work lies at the intersection of ment after leaving office are less supportive of
the concern for the revolving doors and the roleindustry in average, which may be surprising. One
played by personal characteristics. Given that, in ainterpretation is that such difference supports Che's
strict sense, only two of the seven commissioners in (1995) model: more-able regulators planning to ob
Gormley's study were former broadcasters, the tain post-agency employment in industry signal their
analysis should be seen as a quantitative case study.quality by being tougher. However, commissioners
Gormley finds that former broadcasters do tend to who take industry employment after leaving the

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

FCC increase their support for industry interests by cate groups; the other is the direct election of
nearly 11 per cent during their last year in office.regulators.
This may suggest two things. Maybe explicit quid
pro quos are realized close to the end of tenure, The oil shocks in the 1970s ended a long period of
when the terms of such exchanges can be made declining costs and faced consumers with a sce
concrete. Alternatively, consider a commissioner nario where firms filed for rate reviews and typically
near the end of his term who finds out that alterna obtained permission to raise prices. Many state
tive employment opportunities are dwindling and legislatures in the United States then created inde
realizes he has been tough. That person may well pendent consumer advocates in order to protect
decide unilaterally to improve his profile as 'employ consumers from what was perceived as one-sided
able' by voting in support of industry. lobbying. These groups were officially funded, had
the right to be automatically involved in agency
One interesting connection is between the revolvhearings, and could bring in information that could
ing-doors phenomenon and the choice of term lengths diminish informational asymmetries favouring firms.
in regulatory commissions. If terms are very short, Holbum and Spiller (2002) present evidence sug
then banning former regulators from taking postgesting that the creation of those consumer advo
agency employment in industry may be difficult to cates had an important impact on electricity prices.
sustain in practice. High-ability individuals may Holbum and Vanden Bergh (2006) investigate the
simply decide to forgo agency employment in order emergence of independent consumer advocates in
not to lose their chance of obtaining industry jobs.the USA. They find that Democratic state legisla
On the other hand, the combination of short terms tures were more likely to fund consumer advocate
and the possibility of moving on to industry may lead groups. This seems especially tme in states and
regulators to care too much about their reputations periods in which Democrats saw their grasp on
with the market. Leaver (2002) studies the effect of power as transitory. Creating consumer advocate
regulatory term limits on the incidence of utility rate groups appears to have been a way to insulate
reviews in the United States.12 She analyses a panelconsumer protection against probable adverse po
of 99 electric utilities serving 39 states from 1982 to litical developments. This expectation by Demo
1990, which are under the regulation of term-limitedcrats seems to have played a role especially in the
Public Utility Commissioners appointed at the statecreation of advocate groups representing residential
level. The main finding is that reductions in termconsumers, arguably the most likely to become
limits appear associated with a decrease in the unrepresented when the legislative majority changed
propensity of regulators to file for rate reviews incolours.
situations of falling operating costs (which is when
rate reviews would be bad for firms). A different way in which consumers may have
regulation going their way is by controlling regula
tors through the vote. It is not obvious whether the
(iii) Advocate Groups, Regulator Selection,
and Consumer Power effects operate through the provision of different
incentives or through the selection of a different
One important issue that remains to be covered
type of is
regulator. Still, most work in this area finds
the extent to which regulatory outcomes are de consistent with the idea that selection
evidence
methods matter. Most of this work has been done
pendent on pressure stemming from consumers.
Two main possibilities for consumer control are
using cross-sections of utilities, which is potentially
examined. One is the creation of consumer advo
problematic because of omitted variables problems.

12 She raises the point that minimal squawk theory is at odds with classic capture theory. According to Stigler (1971), the longer
a regulator stays in office, the cosier the relationship with firms gets. Presumably, very long terms allow this, so one could observ
a positive correlation between regulatory commissioners facing long terms and policies being more generous to firms (Hagerma
and Ratchford (1978) do find evidence in that direction, using a cross-section of 79 electric utilities in the USA). In contrast, if
regulators care more about protecting their reputations with the market, when term limits are shorter these concerns may be mad
stronger, because regulators will be on the job market sooner. Then it should be shorter terms in office that give incentives to do
favours for firms, in order to stop firms from squawking.

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 E. Dal Bó

Hagerman and Ratchford (1978) use a cross-sec

Besley and Coate (2003) attack the question of
whether selection methods matter using a panel of
tion of 79 electric utilities to investigate determinants
of allowed rates of return and find no evidence that
pass-through decisions regarding fossil-fuel costs.
the method used to appoint regulators matters.13
Their panel covers 42 states in the United States
Boyes and McDowell (1989), however, findfrom that1960 to 1997. They find that elected regulators
allow half as much pass-through relative to ap
when regulators appointed by the executive require
pointed regulators. An attractive feature of this
the approval of the legislature, the price of electricity
tends to be lower, suggesting that legislatures chan
study is that by interacting the selection method with
nel some consumer pressure on executive appoint
cost changes it is possible to identify the role of the
ees. Smart (1994) investigates pressures toselection
keep method even when including fixed effects
basic rates down in telecommunications following
by state in a sample where no states ever switch the
the divestiture of AT&T. Maintaining lowselection
basic method.
rates became difficult with the introduction of com
petition in other service areas. She arguesItthat
has been noted that the determination of regula
allowing for basic rate increases would be hardest
tory outcomes is not solely controlled by regulators
for regulators running in specific elections because
and, possibly, the legislators that supervise them. In
of the salience of the issue to those voting in them.
fact, the courts may affect outcomes because firms,
On the other hand, an appointee of the governor
regulators, and legislators interact under the shadow
would have more political room to let prices go up.eventual court intervention (see, for instance,
of an
Gely
After all, the governor is elected on a platform inand Spiller, 1990; Spiller and Tiller, 1997,
1999).
which telecom prices is only one of many issues, and As a result, the method of selecting judges
could
that very issue may not be salient to the majority of also affect regulatory outcomes. Guerriero
voters. (An argument along these lines would be provides a panel-data study exploiting states
(2003)
later formalized by Besley and Coate (2003).)that An switched judge-selection methods. His evi
intermediate institutional case would be that of dence indicates that states that elect their judges
governor appointees that require legislative confir tend to allow lower pass-through of costs into
mation, especially when this confirmation must take electricity prices. One problem with the work on
selection methods is that it highlights a relative
place in a divided legislature. Using a cross-section
of telecommunication companies, she finds differenceevi only. When elected regulators choose
dence that appointed regulators are associated with 'populist' prices, they may have in mind the right
trade-off between present and future consumers,
higher prices for users in small cities, although this
effect is undone when the regulator must be con and more generous pricing by appointed regulators
firmed by the legislature. Kwoka (2002) uses a be a giveaway to industry. It is also possible that
may
cross-section of 543 US electric utilities and finds populist pricing is too costly from the social point of
that elected commissioners are associated with view because it may lower investment and hinder
lower prices. future service. Analysing regulatory outcomes from
the point ofview of some social efficiency benchmark
A different type of evidence is provided by Fieldsappears
et to be a large pending task for future research.
al. (1997), who perform an event study and show
that a substantial drop in the market value of life
VII. SUMMARY AND PATHS FOR
insurance companies followed the passage ofPropo
sition 103 in California. This proposition altered the FUTURE RESEARCH
mechanism for selecting life-insurance regulators in
a way that was presumed to allow for more con
I have attempted two main tasks in this review. O
was to present in an accessible way the m
sumer influence. It is unclear, however, whether the
theoretical frameworks that academic economi
detected effect reflected a more pro-consumer
use to think about regulatory capture. The other
stance of regulators or, alternatively, more unpre
dictable or incompetent regulation. was to review available evidence on what facto

13 For other early studies, see Harris and Navarro (1983), Costello(1984), Primeaux and Mann (1986), and
(1994).

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

may affect capture and what impact capture may employment. However, term limits that are too short
have on regulatory outcomes. The main lessonsmay make regulators hostages to an extreme need
from prevailing theories are that capture is possible not to 'rock the boat'. The optimal tenure length
because firms have private information that is hard should balance the two opposing concerns that have
for citizens or their political representatives to obbeen studied.
tain. This implies that the emergence of regulatory
agencies should be associated to the production ofIn addition to incentives, interest groups may also
useful, industry-specific, information. However, offer information with the hopes of ensuring more
regulatory agencies can be captured. An example is favourable treatment. One possibility that is, to my
when firms induce regulators to hide information knowledge, uninvestigated empirically is that firms
that could be used to offer consumers a better deal. may out-consult regulators. Thus, regulators may
come to view the world the way firms do, not
The theory we reviewed in section III prescribes because they have been captured through incen
responses that tie regulators' pay to their informa tives, but because they have been convinced. More
tional performance. Such use of wage incentives evidence on persuasion and on whether bad funding
appears impractical, given the difficulty of contract of regulatory agencies makes it more likely would be
ing on regulatory outcomes and on the information valuable.
produced by agencies. Alternatives based on the
use of above-market wages and monitoring to in The empirical evidence on the causes and conse
duce regulators to want to keep their posts also quences of regulatory capture is scarce. Interesting
appear limited when taking into account the size ofwork has been done on the role of monitoring at
the stakes involved. These responses may thencurbing graft and procurement abuses, but direct
have to be complemented with more-involved institests are still lacking ofhow asymmetric information
tutional building: the creation ofbureaucratic proceraises the probability of regulatory capture. More
dures that allow various stakeholders to share infor over, common-agency models that abstract from
mation, the creation of legislative committees thatasymmetric-information problems have been shown
specialize in monitoring the regulator, and possiblyto fit the data on trade policy quite well. We chose
the creation of consumer advocate groups. These as our main model in section III one that puts
elements are all present, to some extent and with asymmetric information at its centre, because it
regional variations, in the current regulatory com would seem that capture would be very unlikely
plex of the United States. were wrongdoing immediately visible to citizens.
(The only exception would be when citizens are
Other theories emphasize that the provision ofpowerless to punish governments that are known to
positive incentives (such as bribes or future industry be ineffective.) However, empirical research has
employment) may not be the only way to influence not yet fully confirmed this presumption.
regulators. The provision of 'trouble' may also
work. The provision of trouble, for instance in theThe empirical literature on capture, especially in its
form of actions that trigger a reputational damageearly years, devoted more attention to the role of the
(or a direct utility loss) for the regulator, has the individual characteristics of regulators and the ef
potential negatively to affect the pool of talent that fects of the revolving doors. Those with industry
can be attracted to regulation. This will be especially background have been shown to be more lenient
important if less talented regulators are more gullible towards industry, but not particularly so once one
and therefore more vulnerable to informational in controls for political affiliations. Posterior industry
fluence from political and industry sources. Nega employment does not seem to have a robust effect
tive incentives can play a larger role when regula on regulatory decisions, except in the last year of
tory employment is weak in terms of stability or time regulatory tenures. Term limits in regulatory bodies,
horizons. In such situations regulators may have however, seem to make regulation more lenient,
more to lose from harming powerful firm interests. perhaps because regulators are more concerned
The view that collusion will be easier to sustain in about their reputations with the market. An impor
long-run relationships calls for term limits on agencytant open question in connection with the revolving

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 E. Dal Bó

doors is whether firms employ former regulators

I will do this by relying on two studies that offer a
micro
mainly because of their technical expertise, or be view of the connection between corruption
cause of their lobbying potential. and firm behaviour.16 The first study, by Kwhaja
and Mian (2005) does not involve regulated firms,
The personal characteristics of regulators may butbeshows that when captured officials grant rents
responsible for the observation that the way toin
firms the costs to society can be large. These
which regulators are appointed seems to make a
authors study distortions in the allocation of loans by
difference to regulatory outcomes. Much inpublic the banks to firms with political connections in
same way in which Supreme Court judges reveal Pakistan. The authors estimate that the politically
induced distortions generate social costs ranging
the inclination of the presidents that appoint them,
from
regulators may owe their stance to the governors or 0.3 to 1.9 per cent of GDP—figures that reach
macroeconomic relevance. The second study, by
legislatures that place them in their jobs.14 Recent
work has shown that elected regulators tend to Dal
haveBó and Rossi (2004), uses a measure of corrup
a more pro-consumer stance. This may reflecttion boththat proxies the corruptibility of all public offi
cials and not just regulators, but contains evidence
the fact that regulators are responsive to the prevail
on the impact of corruption on regulated utilities.
ing pressures (and the electorate is a powerful one),
or that pro-consumer regulators self-select They
into find that if the median Latin American country
in terms of corruption in their sample (Brazil) had the
running for office. More work is needed to disentan
corruption level of the least corrupt country (Costa
gle the selection and incentives effects stemming
from different methods for selecting regulators.
Rica), then electricity distributors would use around
Whether having elected regulators is a good 12
idea
per cent fewer employees and would incur 23 per
cent less operation and maintenance expenditures.
may depend on whether the main concern is capture
This microeconomic evidence is of limited scope in
by firms or pandering to populist views on utility
terms of external validity: it covers a small subset of
pricing. Beyond ideology, evidence is extremely
scarce on whether the talent, professionalism,the firms operating in the countries under study.
and
Clearly,
funding of regulators matter, providing another pos more studies should be performed to com
sibility for future empirical research.15 plete our picture on the microeconomic conse
quences of corruption. However, the magnitude of
the
A final, important issue to consider is that of effects is too large to be dismissed. According
the
tothe
costs of capture. Is capture a big problem? On Dal Bó and Rossi (2004), the damage done by
corruption to the technical efficiency of regulated
one hand, capture could have large distributive
consequences when it transfers income from,utilities
say, is similar in magnitude to that done by
consumers to firms. This could be enoughoperating
of a in an environment characterized by poor
reason for the political principal to want to law curband order, and it is orders of magnitude larger
capture. Moreover, capture may cause net wealth than the damage done by macroeconomic instabil
losses. Measuring these is another area in which ity. Large efforts in both academia and policy circles
more research should be done. Lacking a direct have gone into improving macroeconomic policy,
estimate of how much wealth is destroyed andbyfor good reason. The evidence suggests that we
should probably do more to understand and curb
captured regulation, I would like to offer an indirect
regulatory capture.
indication that capture can be very costly to society.

14 Alt and Lassen (2005) find evidence that the selection method for state Supreme Court members in the United States m
to the corruption levels prevailing in the state. They also provide an indication that the selection effect is likely to be drivi
results.
'5 See Domah et al. (2002) for a study of determinants of the size of electricity regulatory agencies across countries. Their
suggests that smaller countries face a disadvantage at staffing regulatory agencies.
16 Svensson (2005) includes a review of the costs of corruption from the macroeconomic perspective. On procuremen
Telia and Schargrodsky (2003), who show how prices for hospital supplies in Buenos Aires went down by about 15 per ce
a crackdown on corruption. Reinikka and Svensson (2004) show that official graft in Uganda in the mid-1990s absorbed
80 per cent of the public funds from a central government grant intended to finance schools.

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OXFORD REVIEW OF ECONOMIC POLICY, VOL. 22, NO. 2

APPENDIX

(i) Optimal Contracts under Asymmetric Information

The four constraints that the contract offered by the government must respect are:

W(pp 7j) > nl(ph, Th), incentive compatibility constraint of low type (IC low);
Ylh(ph, Th) > If h(pp T¡), incentive compatibility constraint of high type (IC high);
n'(pp T) > 0, participation constraint of low type (PC low);
nh(ph, Th) > 0, participation constraint of high type (PC high).

The government wants to maximize

YW-7)] + (1-Y) [s(ph)-Thl

PC high implies Th > F-q(ph) (ph - ch), and IC low means 7) > F- q(p¡) {pl - c7) + q{ph)A
in the high state only makes it more costly to deter the low-cost firm from claiming co
government will set Th = F-q (ph) (ph - ch). On the other hand, the government has a cl
lower 7) as much as possible while satisfying IC low. Hence, the government will set T
c) + q (ph)Ac. From the last expression we see that, given q\.) < 0, settingp¡ > c; could save the
some transfers. However, departing from marginal cost is a more expensive way of ma
T than settingpl = ct and then satisfying IC low by making direct transfers. The reason is th
from marginal cost pricing destroy surplus. Hence, the government will setpt = c; and T
The problem for the government then becomes to maximize

Y[x(c,) - F - q{ph)Ac] + (1 - Y) [s(ph) -F+ q{ph) {ph - cj\.

The first-order condition for this problem is

-yq'Ac - (i - y) q(ph) + (i - y) i'(ph - cf) + (i - y) q(ph) = o

which then yields

Ph =ch +-^—Ac.
1-y

(ii) Collusion-proof Optimal Contracts

The government wants to maximize

EV= y- F-w} + (1 - yk) {]l[s (c) - 7) (p)] + (1 - p) [x (ph) - Th (p)]},

where, following the logic used before, T[{p) = F + q (ph)Ac, and Th (p) = F-q (ph)(ph-ch). Considering
that wages will be set at the minimum compatible with collusion proofness, the objective of the government
becomes to choose ph to maximize

£r=4(C,KF-^l+(i-TJ I
The first-order condition is

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 E. Dal Bó

-Y*. q[Ph^Ac +(l-yX.){\i[-q\ph)Ac] + (1 - \i)[-q(ph) + <?'(ph)(ph -ch) + q(pJ]} = 0

1 + \(/

which becomes

q\Ph) j- Y^ - 0 ~ Y^)nAc + (1 - y)(/7A - cA)J = 0,

which then, using the fact that 1 - (t. = (1 -y)/( 1 -yX) yields

y * y^ 1 — Ac.
Ph =Ch+- AC + "
l-y (l-y) l + \l/

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