Capital Market Incentives and Regulatory Challenges in Investor-State Dispute Settlement  

By | November 1, 2022

Over the past few decades, there has been growing concern that corporations are increasingly exerting their influence on government policymaking. The discourse in this area, both within the political arena and academia, often focuses on domestic channels that firms use to influence policymaking. This includes channels such as lobbying, political contributions, and charitable giving. However, focusing on domestic channels only captures one dimension of corporate political influence. The past few decades have been marked by massive globalization and rapid growth in the number of multinational corporations. Despite the rapid increase in multinational corporations, there has been limited research on how firms influence foreign government policymaking. 

In a recent paper, we study a previously under-explored channel through which firms can exert influence over foreign governments’ policymaking––investor-state dispute settlement (ISDS), which is the only legal instrument that firms can use to challenge foreign regulation directly. ISDS allows foreign investors to bring claims against sovereign countries that have signed international investment agreements (IIA). IIAs are bilateral (or multilateral) agreements signed by countries, endowing foreign investors with certain benefits, including the right to challenge the governments of other countries through ISDS. Over 1,000 ISDS cases have been filed, with more than 70 billion US dollars awarded against a broad range of countries. When ISDS was established, most of the legal challenges firms filed challenged governments’ direct expropriation of foreign investors’ assets. For example, in SD Myers v. Canada, SD Myers LLC., an American firm whose primary business is to dispose of polychlorinated biphenyl (PCB) waste, challenged the Canadian government’s export ban on PCB as being unfairly discriminatory. The ISDS arbitration panel found that the primary reason for the Canadian ban was not environmental protection but rather safeguarding Canada’s domestic industry from US competition. 

However, a shift has recently occurred in the types of claims challenged through ISDS. A greater number of cases have begun to target government regulatory measures that allegedly hurt the value of investors’ investments. The disputed regulations address many public interest issues, such as the environment, public health, energy, and finance. This trend has prompted widespread claims that ISDS is primarily used as an influence-seeking tool rather than for legitimate purposes and that firms seek to have a “chilling” effect on government policymaking. By filing ISDS challenges, firms can delay the implementation of said regulations and discourage other governments from enacting such policies, potentially even in other countries where the firms operate. For example, two ISDS cases initiated by Philip Morris against cigarette plain-packaging legislation in Australia and Uruguay led several countries, such as New Zealand and the United Kingdom, to put similar measures on hold until a decision was rendered. The legal dispute ran for more than five years. 

Despite these anecdotal shifts in the nature of ISDS, no previous study had empirically explored firms’ incentives for challenging ISDS and the different properties of the claims brought under ISDS. To understand firms’ differing incentives in using ISDS, our study separates ISDS challenges into three heterogeneous categories: industry-wide regulatory challenges, firm-specific challenges, and claims challenging non-regulatory measures. Industry-wide regulation refers to measures that broadly apply to multiple firms within an industry, while firm-specific challenges are cases filed by firms challenging rules that apply only to that specific firm. While challenging industry-wide regulations could yield benefits for the challenging firm, doing so may also benefit peer firms in that industry, thus creating a free-riding incentive. Additionally, existing literature largely treats ISDS users as a homogeneous group of companies, unambiguously labeling them as large multinational corporations, despite the fact that ISDS claimants vary substantially in ownership, incentives, and other economic characteristics. In this paper, we consider the heterogeneous features of firms that may impact their incentives to use ISDS. Specifically, we consider private and public firms’ differential incentives to challenge regulations through ISDS. These differing incentives could be due to public firms’ greater agency frictions or shareholder-stakeholder tradeoffs in their decisions to challenge foreign regulation. 

Our main analysis finds that public firms are associated with a 9-10% higher propensity to file an industry-wide regulatory challenge. We further consider whether being public is associated with the propensity of filing firm-specific rule challenges and do not find a significant association. These results are consistent with the view that there are no differential incentives for public and private firms in challenging firm-specific rules but that private firms may free-ride on public firms’ challenges of industry-wide regulations, resulting in the positive association we document. Next, we find that industry-wide regulatory challenges filed by public firms, on average, take 1.9 years longer to resolve. The longer duration result suggests that firms could delay the impact of pending regulatory measures and potentially discourage other countries from implementing similar regulations. To mitigates the concern that the longer duration may reflect the inherently complicated cases filed by public firms, we conduct the analysis with the investment-treaty fixed effect, in which these cases are filed under the same investment-treaty agreement and are thus similar in nature and scope. We continue to find a robust positive association between public firm challenges and case duration, which lends support to the notion that the difference in the case duration of public and private firms is more likely driven by public firms’ use of ISDS to delay regulation, rather than by inherent differences between the cases that public and private firms challenge. We also explore public firms’ instruments to delay such regulations and find suggestive evidence of experienced lawyers and busy arbitrators. 

We further examine whether the underlying incentives for challenging foreign regulations are consistent with a firm being public, in which the shareholder interests are prominent. We first perform two analyses to test whether challenging foreign regulations is consistent with public firms acting in the interests of shareholders. We find that when the regulations are Environmental and Social (ES)-related, the positive association between firms being public and challenged regulations is stronger. Since ES regulations primarily protect stakeholders (and not primarily shareholders), this reflects firms acting to benefit shareholders by engaging in ISDS. Second, we explore the variation of country characteristics and classify countries based on shareholder-protection strength. If the firm is from a country where shareholder interests are more robustly protected, we expect to find a stronger positive association between public firms and challenged industry-wide regulations; this is what we find. In a final cross-sectional analysis, we also find evidence consistent with the idea that firms with higher expected costs resulting from government policy (i.e., firms with higher stakes in their industries) are more likely to file ISDS challenges, providing evidence for firms’ free-riding incentives.  

Although these results are descriptive, the weight of evidence indicates that public firms have stronger incentives to challenge foreign industry-wide regulations. By splitting on characteristics that differentiate public firms from private firms’ incentives (i.e., shareholder vs. stakeholder interests and public firms’ stakes in their industries), we provide additional evidence that our main association varies in the cross-section as being consistent with public firms having greater incentives to challenge industry-wide regulations. Rather than agency frictions being the dominant force driving the industry-wide regulatory challenges, the divergent interests between shareholders and stakeholders and public firms’ reduced free-riding incentives seem to be the more important factors. 

Our study is among the first to provide systematic empirical evidence on the regulatory chill effect associated with ISDS cases. This paper fills in the gap by conducting large-sample analyses examining the influence of capital market incentives on the initiation of ISDS cases that delay industry-wide regulatory measures. The empirical findings support general concerns about corporate influence, particularly the influence of public firms, on government regulatory activities through the ISDS channel. Furthermore, the empirical finding that public firms are more likely to challenge ES-related industry-wide regulations adds to the growing debate over conflicting interests between shareholders and stakeholders. 


Anthony Le is a Ph.D. candidate at Columbia Business School. 

Lisa Yao Liu is an assistant professor at Columbia Business School.  


This post was adapted from their recent paper, “Capital Market Incentives and Regulatory Challenges in Investor-State Dispute Settlement,” available on SSRN. 

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