Looking Good for the Regulators
Skip to content
Policy Oct 7, 2013

Looking Good for the Regulators

Efforts to avoid regulator scrutiny come with downsides

Based on the research of

Severin Borenstein

Meghan Busse

Ryan Kellogg

No one wants to make a mistake—particularly not one that will be painfully evident to his or her boss the next day, week, or quarterly review. But while making a mistake is bad, people tend to avoid the mere appearance of making a mistake just as vigilantly.

Add Insight
to your inbox.

Employees are often focused on what are known as career concerns. Since promotions, raises, or other benefits frequently depend not just on a person’s performance but on what her boss thinks about her abilities based on that performance, employees consider their professional reputation when making decisions. The familiar “cover your posterior” strategy kicks in: people stick with the safe option rather than taking a smart risk that could go poorly and make them seem less competent.

Career Concerns for Entire Companies?

Meghan Busse, an associate professor of management and strategy at the Kellogg School of Management, wanted to find out if career concerns might play out on a larger scale. Can the desire to cover one’s backside alter the actions of entire companies the way it changes the behavior of individual employees?

Busse and her colleagues, Severin Borenstein at the University of California Berkeley and Ryan Kellogg at the University of Michigan, looked at firms in the natural gas industry. ComEd, PG&E, and other local utilities companies buy gas and deliver it to consumers; regulatory bodies called public utilities commissions oversee the companies, ensuring that they buy enough gas to keep consumers stocked, and at a reasonable price. If a commission thinks a local utility company is behaving imprudently—paying too much for gas, for instance—it can call the utility before a regulatory review, much as a boss might call an underperforming employee in for a performance review.

During a review, Busse explains, regulators “are essentially going to Monday morning quarterback and decide if the distributor made the right choice in any particular circumstance. That’s going be painful and unpleasant because in 20/20 hindsight, everything looks clearer.” The possibility of a review might foster career concerns, thought Busse, encouraging companies to focus less on making the smartest decisions—even if they come with risks—and more on avoiding actions that might look like mistakes.

Avoiding the Appearance of Imprudence

So Busse and her colleagues investigated how utilities buy and sell gas. Local utilities buy much of their gas through long-term contracts. To handle short-term changes in demand, the firms can either buy more gas or sell their surplus on two timescales: during the last week of each month, in what is called the “forward market,” or the day before they need it, in what is called the “spot market.”

If career concerns are guiding utilities’ strategies, Busse hypothesized, the situation they would most want to avoid would be selling their extra gas in the forward market, only to face a spike in demand and have to buy it back—at a much higher price—in the spot market. This would be especially true in tight markets, when demand, and prices, are high. Even if profiting from a surplus seems like a good idea at the time, selling it off only to buy it back for more counts as imprudent behavior that can trigger a review. It would be easy for regulators to home in on the utility’s misstep during that review, Busse explains. “They can point the finger and say: You made a mistake. You made the wrong judgment about how much gas you were going to need.”

But if utilities refrain from selling gas on the forward market and still have to buy more on the higher-priced spot market, this does not necessarily look like a mistake. Sometimes there are limits to what can be purchased on the forward market, so perhaps the utility had simply been unable to buy as much as it needed. “That’s a plausible story because that’s sometimes true,” Busse says. “The regulator can’t say you messed up, because you haven’t taken an action they can point to and know for sure is a mistake.”

When the markets were tight, they saw a forward price premium.

Busse and her colleagues analyzed spot and forward market prices and trading volume data from more than 100 local natural gas markets across the U.S. from February 1993 to March 2008. With these data, they could not look directly at whether individual companies were acting as expected. They could, however, look for larger trends that would result from many utilities behaving this way: when demand is high, there should be fewer trades and higher prices during the forward market than would be expected based on the performance of the spot market, evidence that utilities were hesitant to sell their gas and risk a mistake.

After conducting regression-based analyses of the data, the researchers indeed found this evidence. When the markets were tight, they saw a forward price premium such that a $1 rise in the expected spot price would cause a $1.25 to $1.27 rise in the expected forward price. A higher spot price was also linked to a decrease in trading volume: that same $1 increase in expected spot price leads to an 8.9% decrease in trading volume in the forward market. Other potential explanations for the trends—such as companies paying a premium to lock in a supply of gas or to avoid the risk of paying a still higher price on the spot market—cannot explain the entire pattern of results.

Inefficient Markets

These trends in company behavior could make whole markets less efficient. “You have inefficient outcomes when you have somebody who really needs gas, and is willing to pay a high price, [but] can’t get someone to sell them the gas at that price,” Busse says. If a local distributor in one region likely has more than enough gas to see them through the month, they would, in most markets, sell the extra gas to a distributor in a region where it is getting colder and demand for gas is high. But if the market is tight, the first distributor might not sell—just in case its own area gets cold and it has to buy back gas at a high price. “They’re not willing to sell because they don’t want to take on the risk that they’re going to end up needing it and then be in this really unpleasant prudency review,” she says.

This result built on the earlier research that showed individual career concerns—employees doing what is best for their own professional reputations—could lead to inefficient choices within a company. But as far as the researchers know, this is the first paper that demonstrates how career concerns can actually produce inefficient markets.

The same thing likely happens in other sectors as well, Busse suspects. “There’s a new input supplier, but purchasing managers don’t buy from them because they don’t want to be the ones who tried out something new and derailed the production process,” Busse says. “Maybe this is actually a better input, but nobody will try it. And therefore what would be a market innovation doesn’t happen because nobody’s willing to take the risk and go first.”

Featured Faculty

Associate Professor of Strategy

About the Writer
Valerie Ross is a science and technology writer based in New York, New York.
About the Research

Borenstein, Severin, Meghan R. Busse, Ryan Kellogg. 2012. “Career Concerns, Inaction and Market Efficiency: Evidence from Utility Regulation.” The Journal of Industrial Economics. 60(2): 220–248.

Read the original

Most Popular This Week
  1. Will AI Eventually Replace Doctors?
    Maybe not entirely. But the doctor–patient relationship is likely to change dramatically.
    doctors offices in small nodules
  2. 3 Tips for Reinventing Your Career After a Layoff
    It’s crucial to reassess what you want to be doing instead of jumping at the first opportunity.
    woman standing confidently
  3. What Happens to Worker Productivity after a Minimum Wage Increase?
    A pay raise boosts productivity for some—but the impact on the bottom line is more complicated.
    employees unload pallets from a truck using hand carts
  4. 6 Takeaways on Inflation and the Economy Right Now
    Are we headed into a recession? Kellogg’s Sergio Rebelo breaks down the latest trends.
    inflatable dollar sign tied down with mountains in background
  5. What Is the Purpose of a Corporation Today?
    Has anything changed in the three years since the Business Roundtable declared firms should prioritize more than shareholders?
    A city's skyscrapers interspersed with trees and rooftop gardens
  6. How to Get the Ear of Your CEO—And What to Say When You Have It
    Every interaction with the top boss is an audition for senior leadership.
    employee presents to CEO in elevator
  7. Why We Can’t All Get Away with Wearing Designer Clothes
    In certain professions, luxury goods can send the wrong signal.​
    Man wearing luxury-brand clothes walks with a cold wind behind him, chilling three people he passes.
  8. Why You Should Skip the Easy Wins and Tackle the Hard Task First
    New research shows that you and your organization lose out when you procrastinate on the difficult stuff.
    A to-do list with easy and hard tasks
  9. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  10. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  11. When Do Open Borders Make Economic Sense?
    A new study provides a window into the logic behind various immigration policies.
    How immigration affects the economy depends on taxation and worker skills.
  12. Why Do Some People Succeed after Failing, While Others Continue to Flounder?
    A new study dispels some of the mystery behind success after failure.
    Scientists build a staircase from paper
  13. How Has Marketing Changed over the Past Half-Century?
    Phil Kotler’s groundbreaking textbook came out 55 years ago. Sixteen editions later, he and coauthor Alexander Chernev discuss how big data, social media, and purpose-driven branding are moving the field forward.
    people in 1967 and 2022 react to advertising
  14. How Old Are Successful Tech Entrepreneurs?
    A definitive new study dispels the myth of the Silicon Valley wunderkind.
    successful entrepreneurs are most often middle aged
  15. How Offering a Product for Free Can Backfire
    It seems counterintuitive, but there are times customers would rather pay a small amount than get something for free.
    people in grocery store aisle choosing cheap over free option of same product.
  16. Immigrants to the U.S. Create More Jobs than They Take
    A new study finds that immigrants are far more likely to found companies—both large and small—than native-born Americans.
    Immigrant CEO welcomes new hires
  17. College Campuses Are Becoming More Diverse. But How Much Do Students from Different Backgrounds Actually Interact?
    Increasing diversity has been a key goal, “but far less attention is paid to what happens after we get people in the door.”
    College quad with students walking away from the center
  18. How Peer Pressure Can Lead Teens to Underachieve—Even in Schools Where It’s “Cool to Be Smart”
    New research offers lessons for administrators hoping to improve student performance.
    Eager student raises hand while other student hesitates.
More in Policy