for “innovative” firms, policy influence isn’t limited to lobbying and donations

Left: FDR signs the Glass-Steagall Act of 1933. Right: Clinton signs the Gramm-Leach-Bliley Act of 1999 which largely repealed Glass-Steagall. Source: NYT.

Sociologists, political scientists, and the public at large have long been concerned with the political influence of large corporations. For the past few decades, most research on corporate political influence has focused on a narrow set of obviously political behaviors: lobbying and campaign donations.

Scholars have learned a great deal about why firms donate, the value of those donations, and how lobbying efforts shape the content of policy. And yet, focusing on these narrow aspects of overt political behavior seems to only scratch the surface of the policy influence of large corporations.

In a new paper, sociologist Russell Funk and I argue that scholars must attend to how firms use seemingly non-political, market actions to change the content and meaning of the law. These nonmarket effects of market actions are complements and substitutes to more direct political action.

When firms can’t get what they want through the policy process, sometimes they can get it by engaging in a form of economic “politics by other means.” Through innovation or creative implementations, firms can change the interpretation and consequences of the law without the passage of any new legislation.

The history of financial derivatives offers a clear example of the sort of dynamics we identify. In 1933, Congress passed the Glass-Steagall act which separated out commercial and investment banks. Specifically, banks that took deposits and made loans were not permitted to deal in securities, and vice versa.

By the 1980s, with the memory of the Great Depression fading, the financial sector set its sights on repealing Glass-Steagall and reintegrating commercial and investment banking. But Congressional Democrats proved a major roadblock to repeal efforts. And so, banks found a creative solution: derivatives.

Derivatives are an old concept – a financial transaction whose value somehow hinges on the value of another transaction – but only a few kinds of derivatives were widely used until the 1980s (mostly futures and options).

In 1981, IBM and the World Bank engaged in the first “currency swap”, and in 1982 Sallie Mae (a government mortgage agency) engaged in the first “interest rate swap.” Both kinds of swap took off like gangbusters, and the markets for each reached astronomical sizes. These transactions had some of the features of loans and some of the features of securities. They thus fell outside of the Glass-Steagall regime.

Both commercial and investment banks could trade in swaps, and the two business models converged despite the resistance of policymakers to changing the law. Throughout the 1980s and 1990s, commercial and investment banks had so thoroughly innovated around Glass-Steagall that its actual repeal in 1999 was almost a formality. [Russ and I discuss this example in greater length in a 2014 paper available here.]

This dynamic illustrates one of the two pathways we identify for firms’ market actions to influence the law. Here, we see companies creating new kinds of activities that fall outside of existing regulatory regimes. In so doing, they undermine the ability of those regulations to control market activities.

A more recent example in the same space is the so-called “futurization” of swaps. The 2010 Dodd-Frank reforms attempted to rein in the unregulated swaps markets that emerged in the 1980s-1990s.

Facing new regulations, financial firms found ways to substitute less-regulated futures in place of newly scrutinized swaps. When lobbying efforts proved ineffective in the wake of outcries over the 2008 crisis, innovative market actions offered a partial solution.

Of course, examples like these should make us question the use of the term “innovative” to describe new financial transactions which seem to thrive due to their tax or regulatory benefits.

The case of derivatives and Glass-Steagall offers a nice example of firms innovating around a narrowly-tailored rule by engaging in a previously unforeseen activity. On the flip side, firms may also exercise influence over policy by creatively implementing ambiguous laws.

Sociologists of law (most prominently Lauren Edelman) have identified this phenomenon as “endogenous legal change.” Endogenous legal change occurs when organizations choose how to implement an ambiguous mandate, and then that organizational interpretation becomes the law as judges sanctify compliance with prevailing norms as the proper implementation.

Most scholars of endogenous legal change have focused on examples from workplace discrimination law. Title VII of the 1964 Civil Rights Act offered a sweeping mandate for employers to cease discrimination in employment. But this mandate was light on the specifics.

Title VII left key terms, including discrimination, undefined and placed few explicit demands on employers, other than requiring them to report annually on their workforce composition. Firms turned to new kinds of personnel professionals to design policies that complied with the law.

In particular, firms began to create standardized grievance procedures. These procedures were not specified in the law itself, but as they diffused and became corporate best practices, judges began to accord them increasing deference. This trend culminated in a 1988 Supreme Court ruling which held that “an employee’s failure to use an employer’s internal grievance procedure might protect an employer from liability for harassment by its supervisory employees” (Edelman, 2007: 85), thereby codifying private firms’ interpretive influence over the real effects of Title VII.

These examples showcase how the policy influence of firms is not limited to their direct political action. These pathways illustrate how firms use their market actions (from innovative product offerings to hiring and personnel policies) to shape the meaning and effects of policy.

When faced with a strict mandate that narrowly defines certain activities as impermissible, firms may create new “innovations” that functionally replace prohibited actions. When faced with ambiguous mandates that require broad compliance but leave open the means, firms may creatively implement the law in ways which they find most beneficial, and then influence courts and regulators to accept their interpretations.

Regulators, legislators, and activists attempting to enforce a set of formal rules must be vigilant for such innovations and creative implementations. Just as firms may alter the effects of policies through implementation and innovation, regulators must maintain their own capacity to update rules when existing interpretations no longer work.

Daniel Hirschman is the economic sociology editor for Work in Progress and assistant professor of sociology at Brown University. This article summarizes findings from “Beyond Nonmarket Strategy: Market Actions As Corporate Political Activity”, co-authored with Russell Funk, in Academy of Management Review. This article was originally posted at Work in Progress.

Author: Dan Hirschman

I am a sociologist interested in the use of numbers in organizations, markets, and policy. For more info, see here.

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