Tug of War in Corporate Environmental Lobbying 

By | March 24, 2023

Do firms engage in political competition in environmental lobbying when they have opposing environmental stances? If yes, is there any deadweight loss of corporate value and social resources due to such political competition? Our recent working paper theoretically and empirically explores how firms can compete to capture an environmental policy through lobbying. Corporate lobbying is an essential channel through which corporations influence policymakers’ decisions relevant to their key business interests. With growing global interest in environmentally sustainable business practices, governments are scrambling to introduce environmental policies, and firms are increasingly interested in influencing policymakers to make decisions favoring their environmental stances. Since not all firms have environmentally friendly businesses, firms with opposing environmental stances can fiercely compete to beat the opponent in influencing policymakers’ decisions. Understanding the strategic aspect of corporate lobbying is crucial because the tug of war in corporate lobbying can potentially incur a deadweight loss of corporate value and social resources. 

Theoretical Setting and Predictions 

We first build a model of lobbying decisions among firms with varying environmental stances, Green, Neutral, and Brown. In the model, firms propose a desired level of environmental policy to be implemented and spend lobbying expenditures to influence a policymaker’s decision. A key feature of the model is that a policymaker will likely implement environmental policies favorable to the firms whose lobbying expenditures are the greatest. However, the policymaker does not always follow the proposal of firms with the highest lobbying expenditures, and there exists some policy uncertainty; an environmental policy other than the one proposed by the winner can be implemented. Following the lobbying competition for environmental policy, firms compete in the product market while taking the implemented policy as given. A firm’s marginal cost of production decreases when an environmental policy is implemented in congruence with the firm’s environmental stance. For example, a green (brown) firm’s marginal cost of production decreases (increases) when a more stringent EPA regulation is implemented. A firm must consider the cost and benefit of lobbying expenditures; higher expenditures incur higher costs, but it increases the chance that a more favorable policy is implemented. The model predicts that firms with differing environmental stances end up engaging in a tug-of-war in environmental lobbying, resulting in a deadweight loss that raises the cost of capital and accompanies the impairment of a firm’s long-term investments, sales growth, profitability, and employment.  

One of the model’s key predictions is a U-shaped relation between corporate environmental stances and lobbying expenditures. In other words, firms in opposing environmental stances––Brown and Green firms––spend much more lobbying expenditures than firms in the neutral spectrum. We call the excessive lobbying expenditure among the Green and Brown firms the “tug of war” effect. Another prediction of the model is that the tug-of-war effect is more pronounced when the policymakers’ decision-making is more uncertain. The policymakers’ environmental policy can be more or less stringent than the level proposed by Green or Brown firms. Since a winning firm’s operating profit increases in a convex manner as more favorable environmental policy is implemented, the policy uncertainty makes both firms find it optimal to lobby more extreme policies in their favor, amplifying the “tug of war” effect. The model also predicts that financial constraints restrain excessive lobbying expenditures. As the financial constraints become more binding, firms find it optimal to curtail their lobbying expenditures. Moreover, the model predicts that higher product market competition leads to a larger tug-of-war effect as firms’ marginal benefit from winning the lobby increases. 

Empirical Setting and Findings 

We test the model’s prediction using mandatory lobbying reports filed by U.S. lobbying entities. U.S. firms have been filing the “Lobbying Report (LD-2)” mandated by the Lobbying Disclosure Act of 1995. This law requires firms to report detailed information about lobbying activities, including lobbying areas and expenditures. We focus on lobbying activities related to environmental issues. We also derive a firm’s environmental stance based on environmental scores provided by the Morgan Stanley Capital International (MSCI) KLD database.  

The empirical analysis confirms a clear U-shaped relation between firms’ environmental stances and lobbying expenditures. We also find that Green and Brown firms spend more on environmental lobbying expenditures when the Climate Policy Uncertainty (Gavriilidis (2021)) is higher, confirming the model’s prediction. The Green and Brown firms reduce environmental lobbying when their financial constraints are binding, suggesting that the excessive lobbying expenditure may not be an essential part of the spending plan. The tug-of-war effect is also more pronounced when the product market competition is more intense. 

We also evaluate the effect of tug of war in environmental lobbying on firms’ cost of capital, long-term investment, sales growth, profitability, and employment. We find that firms experience a higher cost of capital when engaging in the tug of war, consistent with Grotteria (2022), showing that firms with excessive lobbying expenditures have significant increases in their cost of capital. We also find that the firms will likely have a lower long-term investment in R&D and capital expenditures. Their sales growth, profitability, and hiring also suffer. These results suggest that the tug of war in environmental lobbying can potentially affect a firm’s viability.  

Conclusion  

In this paper, we examine the strategic lobbying decisions of firms with opposing environmental stances. A key prediction of the model is that lobbying expenditures increase as firms’ environmental stances go to extremes. We test and confirm this prediction of the model using lobbying reports filed by U.S. lobbying entities. We also empirically test and confirm other model predictions; the tug-of-war effect is more pronounced when environmental policy is uncertain, financial constraints are not binding, and the product market competition is more intense. The tug of war increases firms’ capital costs, reducing real investments and profitability. A potential policy implication is that government needs to set a clear policy direction regarding environmental policies so firms can avoid costly lobbying tug-of-war and instead invest in new technologies to transform their businesses to align with environment policy. 

 

Byeong-Je An is an assistant professor of finance at the Nanyang Business School, Nanyang Technological University. 

Hyun-Soo Choi is an associate professor of finance at the KAIST College of Business, Korea Advanced Institute of Science and Technology (KAIST) 

Hugh Hoikwang Kim is an associate professor of finance at the Darla Moore School of Business, University of South Carolina.  

Paul Youngwook Kim is a Ph.D. student at the KAIST College of Business, Korea Advanced Institute of Science and Technology (KAIST). 

 

This post is adapted from their “Tug of War in Corporate Environmental Lobbying” paper available on SSRN. 

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