Corporations and Regulators: The Game of Influence in Regulatory Capture

In a market system, regulations are designed to prevent or rectify market failures that inhibit fair exchange, such as monopoly or transactions with hidden costs. Because regulations reduce profits to those possessing unfair advantage, corporations (whether individuals, companies, or other collective organizations) are motivated to influence regulators. Regulatory bodies created to protect the market are instead co-opted to advance the interests of the corporations they are charged to regulate. This wide-spread influence, known as “regulatory capture,” has been recognized for over 100 years, and according to expectations of rational behavior, will exist wherever it is in the mutual self-interest of corporations and regulators. Under the assumption of economic rationality, a theoretical analysis suffices to determine where regulatory capture will occur. Here we model the interaction between corporations and regulators using a new game theory framework explicitly accounting for players’ mutual influence, and demonstrate the incentive for collusion. Communication between corporations and regulators enables them to collude and split the resulting profits. We identify when collusion is profitable for both parties. The intuitive results show that capture occurs when the benefits to the corporation outweigh the costs to the regulator. Under these conditions, the corporation can compensate the regulator for costs incurred and, further, provide a profit to both parties. In the real world, benefits often far outweigh costs, providing large incentives to collude and making capture likely even when strict rationality may not apply. Regulatory capture is inhibited by decreasing the influence between parties through strict separation, independent market knowledge and research by regulators, regulatory and market transparency, regulatory accountability for market failures, widely distributed regulatory control, and anti-corruption enforcement. We discuss the impact of integrity of the regulator in the analysis, relaxing the rationality assumption. We also discuss various ways regulators themselves may seek opportunities to benefit.