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A better understanding of corporate strategy under regulatory uncertainty enables policy makers to improve policy making efficiency and enhance regulations’ effectiveness. Based on a review of the literature on policy formulation, we propose that regulatory uncertainty is characterized by a dependence on political negotiation, a discrete scenario structure, and a discontinuous resolution. Data from a worldwide survey show that firms pursue response strategies to regulatory uncertainty that address these characteristics by participating in policy making and increasing strategic flexibility. Surprisingly, the results also show that regulatory uncertainty only partly causes firms to postpone strategic decisions. We find that existing regulation and a need to act quickly despite regulatory uncertainty are opposed to the pursuit of a postponement strategy. We conclude that improving the mechanisms by which firms participate in early stages of the policy making process could enable them to operate in a more target-oriented manner, allow for more efficient policy implementation, and increase a regulation's effectiveness.

Political scientists have extensively studied impediments within the political arena which reduce the efficiency of the policy making process (e.g., Besley and Coate, 1998, deLeon, 1992, Sabatier, 1991 and Schulz and König, 2000) and lead to ineffective regulations (e.g., Fort and Rosenman, 1993, Mazmanian and Sabatier, 1981, Mazmanian and Sabatier, 1983 and Scharpf et al., 1978). Although the literature predominantly focuses on intragovernmental obstacles, aspects outside of the political arena also affect regulations’ effectiveness (Ringquist, 1995). Firms’ strategic responses toward a regulation constitute such an external influence (Rugman and Verbeke, 1998a) which may or may not be in accordance with the intentions and procedures of policy makers. Among other issues, firms concerned by a new regulation are typically exposed to regulatory uncertainty that is intrinsic to policy formulation (Birnbaum, 1984 and Hoffmann et al., 2008). As a consequence, these firms often pursue specific strategies that enable them to cope with this uncertainty (Delmas and Tokat, 2005 and Smith and Grimm, 1987). However, insufficient knowledge about the impact of regulatory uncertainty on firms’ strategies can affect the efficiency of the policy making process and makes it difficult for policy makers to design effective regulations (Arentsen et al., 2000 and Scharpf, 1988). For example, uncertainty associated with a specific regulation can impede firms’ compliance with this regulation (Hoffmann, 2007, Levy, 1997 and Paulsson and von Malmborg, 2004), thereby thwarting the regulation's objectives. Therefore, it is important for policy makers to develop a detailed understanding of firms’ responses to regulatory uncertainty. However, this research area has not systematically been explored. This paper contributes to closing this gap by investigating which strategies firms pursue in response to regulatory uncertainty. Multilateral environmental regulations are particularly difficult to design and anticipate because they often only specify environmental goals and require individual governments to pass national regulations to achieve these goals (Christmann, 2004 and Levy, 1997). Accordingly, the growing number of environmental regulations implemented and enforced at an international level increasingly exposes firms to regulatory uncertainty (Hoffmann and Trautmann, 2008, Kolk and Pinkse, 2004 and Rugman and Verbeke, 1998b). Long periods of regulatory uncertainty are not only challenging for business, they are furthermore particularly critical from a societal perspective. This is due to the fact that the resulting ineffective environmental regulations and firms’ possibly unwitting contravention of regulatory objectives might have severe and potentially irreversible consequences for the natural environment (Faucheux and Froger, 1995). To address the effect of regulatory uncertainty on corporate strategy, we review the literature on policy formulation and identify three characteristics of regulatory uncertainty that distinguish this type of uncertainty from other uncertainties in firms’ business environment. From these characteristics we derive hypotheses on strategies firms are likely to pursue when facing regulatory uncertainty. Focusing on environmental regulation, we then test our hypotheses with data from a worldwide survey of corporate response strategies to uncertainty associated with post-Kyoto regulation on climate change. Our results show that lobbying is strong and widespread across industries and regions. Similarly, firms across all industries and regions prepare for a range of different outcomes of the post-Kyoto policy process, indicating an inefficient use of resources due to regulatory uncertainty. At the same time, however, only a minority of firms actually postpone investment decisions, contrary to the frequent threats of firms not to invest if governments do not provide predictable investment conditions.

The objective of our study is to investigate corporate strategy under regulatory uncertainty. To this end, we identify specific characteristics of regulatory uncertainty from the literature on policy formulation and analyze appropriate strategies particularly directed at these characteristics. The results confirm our hypotheses that the strategies firms pursue specifically respond to the characteristics of regulatory uncertainty. Findings show that the higher the uncertainty firms perceive regarding the considered regulation, the greater the extent to which they participate in the corresponding policy making process and prepare for a variety of possible regulatory scenarios through increased strategic flexibility. In addition, participation and flexibility are commonly pursued to a great extent across most industries, with utilities especially applying these two strategies to a greater extent than other firms. At the time of our study, these firms were emphatically asking policy makers for planning reliability for the large investments in plant replacements required over the next decade. Moreover, one utility had just initiated the construction of a pilot coal power plant with integrated components to separate CO2 from other emissions and capture it, while at the same time investing in technologies to generate energy from renewable resources. This behavior toward the post-Kyoto debate seems to replicate the successful strategy enacted by the European utilities industry during the political negotiation on the design of the EU Emission Trading Scheme (EU ETS), with utilities lobbying extensively to secure an abundant and free allocation of allowances (Michaelowa and Butzengeiger, 2005) while at the same time seeking increased flexibility through diversification (Hoffmann, 2007). However, despite the demonstrated adequacy of participating in the policy making process and increasing strategic flexibility when facing regulatory uncertainty, the high prevalence of both strategies is surprising given that they also entail unfavorable effects for firms. Firstly, effectively contributing to the policy making process requires the deployment of additional resources and the complicated development of a credible reputation with policy makers (Hillman and Hitt, 1999). For example, the Cement Sustainability Initiative, a vehicle used by basic material firms to influence the design of a post-Kyoto regulation of their industry, is investing about one million dollars per year for monitoring members’ compliance with their voluntary CO2 emission reduction targets (Busch et al., 2008), thereby demonstrating proactive and socially responsible behavior. Secondly, firms also have to commit considerable resources to hold ready alternative strategic options (McGrath and Nerkar, 2004). Follow-up interviews in the aviation industry revealed that airlines with localized route networks, such as regional or leisure carriers, were often trying to diversify their business portfolio by adding intercontinental flights that were potentially to be excluded from regulation in a much discussed regulatory scenario. Similarly, besides trying to increase current engine efficiency, most car manufacturers simultaneously worked on alternative fuels, for example biofuels or compressed natural gas, and also developed electric and fuel cell vehicles that do not produce direct CO2 emissions. As expected, the study also indicates that firms that actually postpone strategic decisions do so due to a perception of higher levels of regulatory uncertainty. Surprisingly, however, postponement was not as widespread as derived from theoretical considerations or as frequently claimed by firms, for example prior to the policy makers’ decision on how to allocate emission allowances in the EU ETS (Sullivan and Blyth, 2006). Only about one-third of the respondents pursued a postponement strategy in the light of post-Kyoto regulatory uncertainty, while the remaining firms did not postpone strategic decisions to respond to regulatory uncertainty. Likewise, firms applied postponement to a considerably lower extent than participation and flexibility. Reasons for the latter can be derived from the control variables. First, our results show that the exposure to pressures from existing regulation counteracted firms’ postponement of strategic decisions. While this finding is not surprising per se, it emphasizes the importance of providing a regulatory framework for firms’ CO2 emission reduction activities. The exposure to existing regulatory pressures to reduce CO2 emissions seems to have prevented firms from holding back with strategic decisions, many of them likely related to emission reductions such as investments in increased energy efficiency. As expected because of the EU ETS, such pressures were significantly higher for firms in Europe than for those in other regions. Consistently, European firms postponed strategic decisions to a lower extent than other firms (p < .10). Second, results show that firms’ perceived need to avert a threat or take advantage of an opportunity resulting from regulatory uncertainty was opposed to the pursuit of a postponement strategy. The rationale for firms to participate in policy making and to increase their strategic flexibility but to not postpone strategic decisions despite the high level of regulatory uncertainty could be ascribed to the stage of the political negotiation. At the time of our study, the decision making process of a post-Kyoto regulation was still far from any agreement, with the range of potential regulatory outcomes being correspondingly broad. Early stages of regulatory policy making provide numerous possibilities for firms to exert influence on policy makers and to direct the outcome of their negotiations toward a particular objective (Ullmann, 1985). Furthermore, the wide array of possible regulatory scenarios requires a large number of strategic options to be available to the firm, i.e., a high degree of strategic flexibility (Aaker and Mascarenhas, 1984 and Bowman and Hurry, 1993). In contrast, respondents’ comments in the open text fields and during follow-up interviews suggest that there might be situations during early policy making in which it is more beneficial for firms to not postpone strategic decisions. The low extent to which transportation firms postponed strategic decisions substantiates this notion. The high regulatory uncertainty perceived by these firms is reflected in the fact that policy makers had, at the time of our survey, just started to discuss the post-Kyoto handling of CO2 emissions from road traffic and aviation. Follow-up interviews in the industry revealed that firms attempted to build up their levels of credibility with policy makers to add authority to their lobbying activities. They hoped to prevent an overly strict regulation by emphasizing their proactive behavior and voluntarily demonstrating environmental responsiveness early on in the policy making process. As a result, instead of postponing strategic decisions firms in the transportation industry took action on short notice, for example by launching comprehensive energy efficiency initiatives or investing in fleet modernization programs. In addition, postponing strategic decisions during the early stages of a lengthy regulation formulation process might entail unfavorable effects for the firm which outweigh the potential benefits gained from making strategic decisions later under more certainty. This may be particularly true if the time span before the resolution of regulatory uncertainty is long as a firm runs the risk of losing competitive advantages or missing opportunities in the meantime until it makes the decision. Moreover, the longer the period a firm has to postpone strategic decisions for, the more difficult it is to assess the potential risks associated with this postponement and to evaluate the impact the postponement might have on the firm's corporate performance. Accordingly, similar to participation and flexibility strategies, pursuing a postponement strategy involves shortcomings firms have to cope with, particularly during the early formulation of a new regulation. As a result, postponing strategic decisions might be more prevalent in the more advanced stages of regulatory decision making when firms expect regulatory uncertainty to be resolved soon.