Entrepreneurship and Public Policy Lecture 7: Three Examples of Regulation: Environmental, Labor Market, and Workplace Safety Regulation

EPP – Lecture 7 -2 Spring 2009 In This Lecture, We Review the Following Questions in Three Substantive Regulatory Areas What concerns drive regulation in this area? How does the regulatory environment distinguish between large and small firms? How have regulatory policies affected small businesses? Do small firms respond differently to regulation?

EPP – Lecture 7 -3 Spring 2009 Lecture Overview Area 1: Environmental regulations Area 2: Labor market regulations Area 3: Workplace safety regulation

EPP – Lecture 7 -4 Spring 2009 Focus of the Environmental Regulations Environmental regulations attempt to reduce the negative effects of manufacturing on environment and people’s health –For example, without regulations firms would overpollute (negative externality) Historically regulations targeted large polluters, but over time smaller firms have attracted attention too

EPP – Lecture 7 -5 Spring 2009 Components of the Regulatory System Surrounding Environmental Protection Regulation Enforcement –Government enforcement mechanisms –Liability or citizen enforcement mechanisms

EPP – Lecture 7 -6 Spring 2009 Environmental Regulations Often Impose Different Requirements on Firms of Different Sizes Small firms are rarely exempt from the overall regulation, but may be exempt from certain requirements Over 50 regulations are tiered based on either firm size or the amount of pollution released (SBA, 1995) Small firms may be required to meet less stringent emission or treatment technology standards Small firms may be relieved from some paperwork requirements

EPP – Lecture 7 -7 Spring 2009 Other Regulatory Characteristics May Create Disadvantages for Small Firms Grandfathering provisions allow older firms to postpone compliance Large firms may have possibility to tailor regulations to their experiences and capabilities (regulatory capture)

EPP – Lecture 7 -8 Spring 2009 It May Be Costly for Small Firms to Comply with Environmental Regulations Relative cost of compliance may be higher for small firm than for large firms –Pollution reducing equipment may increase the minimum scale of production –Economies of scale in discovering and understanding environmental regulations and in complying with required paperwork Evidence on the role of regulatory interventions on the minimum efficient size of a plant is mixed –Some firms found ways to convert environmental regulations into competitive advantage (save inputs so input production costs go down) –More costly to enter the industry since firms may learn over time about more efficient compliance

EPP – Lecture 7 -9 Spring 2009 There May Be Asymmetries in Enforcement among Small and Large Firms Limited enforcement budgets may cause agencies to focus enforcement efforts on large firms Large firms may be influential so that they directly or indirectly influence enforcement priorities Ultimate impact on large firms may be smaller if they can successfully defend themselves against legal action Environmental groups are more likely to target large firms (presumably because their concern about reputation will make them more likely to settle)

EPP – Lecture Spring 2009 Tort System is an Alternative to Active Regulatory Oversight Firms face liability for release of pollutants into the environment –Example: superfund program: imposes liability for the clean up of hazardous waste sites Small firms accounted for the majority of businesses potentially liable for clean up Regulation may allow citizens to bring enforcement action Liability based approach may be more effective for firms that have “deep pockets”

EPP – Lecture Spring 2009 The Evidence About Combined Effect of Regulation on Small Firms Is Mixed May vary by industry and type of environmental regulation Compliance cost asymmetries that disadvantage small firms may be offset by statutory and enforcement asymmetries that favor them Some find that that environmental laws place larger burden on small manufacturing plants Large firms may benefit because less competition from small firms, as fewer small firms are entering the market No clear answer about differential impact on small versus large firms

EPP – Lecture Spring 2009 There Are Many Areas for Future Research on Environmental Policymaking Since major environmental initiatives were formulated with large firms in mind, we need to understand whether a different approach to regulation is needed to deal with operations of small firms We know very little about the effect of trends in environmental regulation on small firms (I.e. voluntary enforcement agreements) What are the relative benefits and costs associated with regulation

EPP – Lecture Spring 2009 Lecture Overview Background on the regulation and entrepreneurship Area 1: Environmental regulations Area 2: Labor market regulations Area 3: Workplace safety regulation

EPP – Lecture Spring 2009 Employment Policies Regulate Relationships between Employers and Employees Regulation restricts ways in which businesses interact with prospective, current and former employees Addresses concerns that one party might intentionally or unintentionally impose harm on the other –Discrimination against certain groups of current, or potential employees that denies them access to jobs or fair wages –Hostile or unsafe work environment –Exercise of market power to drive down wages –Lost wages due to job loss, workplace injury –On employer side: loss form theft of intellectual property or a client base

EPP – Lecture Spring 2009 Size Threshold Often Used to Exempt Small Firms From Employment Regulations Examples of thresholds –Family and Medical Leave Plan (exempts firms with less than 50 workers) –Americans with Disabilities Act (15 workers) –Worker Adjustment and Retraining Notification Act (100 workers) –Occupational Safety and Health Act (11 workers) –Age Discrimination in Employment Act (20 workers) –Civil Rights Act of 1964 (15 workers) –Fair Labor Standards Act (2 workers) Employers that fall below the size threshold cannot be sued, fined, charged or otherwise reprimanded under the aegis if the law. These employers are not subject to record keeping associated with these laws

EPP – Lecture Spring 2009 Most Enforcement of Employment Regulation Happens through Court System An employee who believes that his or her employer has intentionally harmed him or her has the right to file a civil suit and seek damages from the employer Federal, state and local regulations increase the risk of litigation by giving a government agency the authority to investigate firm behavior –Equal Employment Opportunity Commission investigates employee complains against firms in the areas of antidiscrimination and may bring suits Employer may use the court system to enforce an employment agreement if an employee fails to live up to the terms of a contract

EPP – Lecture Spring 2009 Court Litigation May Depend on Firm Size Focus of court litigation may depend on the resources available to firms –Employees may be more likely to go after large firms with deep pockets –It is easier to identify statistical irregularities in large firms –On the other hand, larger firms may have stronger incentives to spend substantial resources on defense Difficult to establish who faces greater burden of litigation –Pendell and Hinton (2007) suggest that the legal costs per dollar of revenue are substantially greater for small businesses than they are for large businesses

EPP – Lecture Spring 2009 More Research Is Needed Little empirical research that documents the effects of employment regulation in general and the effects on small businesses in particular Little evidence of the effectiveness of the exemption thresholds More careful consideration of unintended consequences of policy and regulation in the workplace is warranted The benefits of staying below a certain size threshold might induce some firms to limit growth

EPP – Lecture Spring 2009 Lecture Overview Background on the regulation and entrepreneurship Area 1: Environmental regulations Area 2: Labor market regulations Area 3: Workplace safety regulation

EPP – Lecture Spring 2009 Occupational Safety and Health Administration (OSHA) Regulates Employers Safety standards –Falls, explosions, fires, cave-ins, machine and vehicle operations and maintenance Health standards –Exposure to health hazards through engineering controls and use of personal protective equipment

EPP – Lecture Spring 2009 Several Reasons to Expect the Risk of Injury to Be Higher at Small Firms Smaller firms may expect lower savings from preventing injuries, since there is little or no experience rating in workers compensation insurance More likely to employ high-risk workers Less likely to realize economies of scale Less likely to be inspected, reducing the marginal benefits of compliance

EPP – Lecture Spring 2009 OSHA Regulatory Approach Considers Size of the Firm Exempts establishments with fewer than 11 workers from regular “programmed” inspections Considers firm size when assessing penalties for violating safety and health standards

EPP – Lecture Spring 2009 KRI Research Highlights Opportunities for Improving the Regulatory Environment It has long been known that small establishments have higher fatality rates than larger establishments KRI research examined the distinction between small firms and small establishments to determine the role that firm size plays Study found that small, single-establishment firms have much lower fatality rates than small establishments that are part of larger firms This points to a need to distinguish between small firms and small establishments in policymaking and in research Also suggests that targeted regulatory enforcement might be useful

EPP – Lecture Spring 2009 Discussion: Example of Food Safety Regulation Reasons for regulations –What are the costs of regulations? –What are the benefits of regulations? –Do you think possibility of exempting small businesses in this industry is justified in terms of costs and benefits of regulation? Enforcement –What are the pros and cons of government enforcement of regulations? –What is the role of civil enforcement in uncovering the case? –Would this violation be uncovered in case of the small firm? Do firms have incentives to self-regulate and/or comply with regulation? Does it depend on firm size?