Reverse Regulation? National Political Budget Cycles and the Moderating Power of Transnational Rating Agencies

Abstract

Regulatory theory assumes that national governments seek to constrain undesirable firm behavior, either through direct governmental oversight, or through oversight delegated to non-governmental organizations. We reverse that assumed relationship with the first study investigating when and how certain for-profit businesses of international scope constrain undesirable national government behavior. We ground our study in transnational regime theory explaining when and how for-profit firms position themselves as private regulators, and political budget cycle theory explaining when national governments are more likely to violate regulatory policies and respond to private regulatory enforcement by these for-profit firms. We document empirical support for our framework through analyses of sovereign credit ratings published by major credit rating agencies (CRAs) and borrowing by 63 national governments holding 111 executive elections from 2001-2011. Governments borrow less excessively during election years when CRAs put them on watch for a sovereign rating downgrade, which hurts re-election prospects in the short term and raises national borrowing costs in the longer run. Our study suggests new avenues of management research investigating when other for-profit firms (e.g., insurance firms) are more likely to constrain undesirable government behavior, and new avenues of public policy research aimed at using for-profit firms to discipline developing country governments (e.g., Cape Verde) trying to maintain responsible fiscal policies as they democratize.