The Project Twins
When US President Donald Trump took office, addressing the “revolving door”—the movement of people between industry and government—ranked high on his agenda. In his second week, with members of his staff steps away, he signed new ethics rules while saying, “Most of the people standing behind me will not be able to go to work or do anything adverse to our wonderful country. Five-year ban. It’s a two-year ban now and it’s got full of loopholes.”
But the revolving door proved too irresistible not too push. The Trump administration hired former industry lobbyists for prominent jobs, and several cabinet positions came straight from corporate America. Even before Trump had a chance to sign the ethics order, which critics complained had its own loopholes, his former campaign managers had set up a lobbying shop.
Despite years of political bluster, policy makers haven’t been able to keep the revolving door from spinning. This is partly because critics of the regulator-industry churn are basing their concerns largely on anecdotes, as there’s more innuendo than empirical evidence of a big problem. But this is changing as researchers analyze data to learn more about the revolving door and its cousin, “regulatory capture.” Research is establishing just how many people are actually moving between government and industry (and back) and what effects their movement has had on regulators’ actions. The findings are also producing some disagreement about how concerned the public should be—and whether the door should continue to spin unabated.
Behind the revolving door is the idea of regulatory capture. Forty-six years ago, the late George Stigler described how a regulatory body tasked with protecting the public interest would ultimately be “captured” to serve the interests of the regulated industry.
Chicago Booth’s Sam Peltzman expanded on this theory, arguing that regulations come about through a balancing act involving politicians and interest groups, which can be companies or other affected parties. Politicians seek support from companies seeking more or less regulation in exchange for campaign contributions, and from voters who will trade their votes in exchange for the policies they want. According to Peltzman, a politician will lean in favor of the interest group that keeps her in office.
Couple these theories with allegations of capture. In Japan, critics of nuclear power suggest that regulators, who are sometimes offered lucrative jobs as plant operators, allowed industry too much influence when writing safety and inspection rules, contributing to the Fukushima Daiichi nuclear meltdown in 2011. The United Kingdom’s customs authority has also been accused of having too cozy a relationship with accountancy firms, causing an unwillingness to crack down on tax avoidance and evasion that save multinational companies billions of pounds in taxes.
But anecdotes, however suggestive, aren’t proof that regulators are shirking their duties. The US Securities and Exchange Commission dropped an inquiry against Deutsche Bank in 2001, and SEC enforcement director Richard H. Walker took a job at the bank a few months later. Are those two events related? In Rolling Stone, writer Matt Taibbi found it concerning, pointing out a decade later that former SEC personnel continued to be well represented in the private sector.
The circular nature of the case illustrates the revolving-door dynamic that has become pervasive at the SEC. A recent study by the Project on Government Oversight found that over the past five years, former SEC personnel filed 789 notices disclosing their intent to represent outside companies before the agency—sometimes within days of their having left the SEC. More than half of the disclosures came from the agency’s enforcement division, who went to bat for the financial industry four times more often than ex-staffers from other wings of the SEC.
But there’s been no proof of quid pro quo. Now the Brattle Group’s Haris Tabakovic and Chicago Booth’s Thomas Wollmann say they’ve found such proof—in the US Patent and Trademark Office.
The USPTO is one small part of the government bureaucracy. Its examiners issue patents, granting exclusive, if temporary, use rights to inventors who have come up with the latest process, machine, or other such thing that can be legally patented. The office has 8,350 patent examiners, who review patent applications. A good number of them move on to jobs in industry.
So did the examiners who moved to industry behave any differently from the rest? Analyzing the data, Tabakovic and Wollmann find these examiners granted more patents than their peers, particularly to the companies that eventually hired them.
Tabakovic and Wollmann combed through patent applications retrieved from the Patent Examination Research Dataset. These documents list the name and unique identifier of each patent examiner, the name and address of the company applying, and the outcome of the process. Using a roster with names of people legally allowed to file for a patent on behalf of a company, the researchers determined which examiners left to work in industry, as well as whether they wound up working for a company for which they had previously granted a patent.
The data set from 2001 to 2015 included more than 10,000 patent examiners and over 1 million applications, of which 63 percent were approved. During these years, about 1,000 patent examiners left the USPTO to become patent practitioners, and those who left were 10 percent more likely to grant patents. The revolving-door examiners granted 10–16 percent more patents to companies for which they went to work.
Pennsylvania State University’s Jess Cornaggia and Kimberly Cornaggia, and University of Texas at Dallas’s Han Xia find a similar pattern at credit rating agencies, the private companies and quasi regulators tasked with grading corporate debt. Like patent examiners, employees at credit rating agencies often move on to industry. And the researchers find that credit analysts who left ratings agencies inflated the ratings of the companies they went to work for by between 0.18 and 0.23 notches, or grades, on average. Equity analysts may be affected too: in the year leading up to their departure for industry, analysts gave the companies they went to work for more favorable forecasts and recommendations, according to research by UC Irvine’s Ben Lourie. They even went so far as to downgrade competitors.
Favoring their future employers
In credit analysts’ last year on the job, some partiality emerges.
These patterns suggest a link between the revolving door and favorable decisions made toward companies. However, these patterns alone don’t suggest intent. While Lourie sees his data as evidence of capture, he says he can’t say that it approaches quid pro quo. “If you are interviewing, the company knows your opinion on them. If your opinion isn’t bullish, why would they hire you?” he says. Although there’s a possibility that an analyst could purposely inflate forecasts to curry favor, there’s no definite connection.
“The fact that there is this opportunity is probably causing the analyst to change behavior, even if it’s innocuous,” Lourie says. “That’s the problem with the revolving door.”
Back in the patent office, it’s impossible to say from these data alone whether examiners approve more of a company’s patent applications because they hope to secure a job with that company. It’s entirely possible that an employer who has a good experience with an examiner can develop a high opinion of that person. It’s also possible that a high-performing examiner may want to work for a company that is successful.
In an attempt to tease out intent, the researchers looked at areas they assumed examiners might want to live, using where they previously lived as a proxy for this. Tracking where patent examiners had gone to college, the researchers find that examiners were 10 percent more likely to grant patents to companies located near their alma mater—and to companies close to the places the examiners wound up taking jobs.
“Opacity is the friend of corruption. And with the SEC in particular, we have a difficult time getting data on their enforcement processes.”
—Ed deHaan
Wollmann views these patterns as evidence of favoritism—the kind that causes people to lose trust in regulators. “I don’t think that when you start at the patent office, one of the firms calls and says, ‘If you grant our patents when you see them, we’ll have a job for you on X day,’” he says. More likely, he suggests, there’s simply a norm that develops where patent examiners learn to keep their future career aspirations in mind when making decisions. “It starts out a bit benign,” says Wollman, but it ends up turning into corruption.
The Cornaggias are less convinced that something nefarious is going on. They conducted research with Michigan State University’s Ryan Israelsen and find, as Tabakovic and Wollmann did, that the analysts favored institutions from where they used to live. The researchers employed the first three digits of analysts’ Social Security numbers (available from public-records databases) to determine where an analyst was likely raised. They confirm state of origin using the analysts’ alma mater, obtained from LinkedIn résumés.
Analysts from ratings agencies who reviewed municipal-bond issuers from their home state rated them higher than those raised elsewhere. It’s not that the higher-rated analysts simply knew more about their home state: comparing analysts living in the state of the issuer to analysts who had moved away, the researchers find those still in the state rated the issuer more harshly, while those who moved away were more lenient.
They draw a benign conclusion, however. They interpret the pattern as evidence that regulators lose objectivity, but for reasons that could be unrelated to the promise of a job. “If I leave, I have what the psychology literature refers to as ‘memory bias.’ I remember happy things about the place,” Kimberly Cornaggia says. “It’s possible it’s fraudulent quid pro quo, but I don’t think that’s the case.”
Here’s another wrinkle: not all research conducted finds evidence of regulatory capture, much less intent. Some findings suggest that regulators are actually tougher on potential employers—and get hired because private-sector companies want to employ talented people who know the ins and outs of the regulatory system.
The Federal Reserve Bank of New York’s David Lucca, Stanford’s Amit Seru, and University of British Columbia’s Francesco Trebbi used a networking website to build a data set of the career paths of more than 35,000 banking regulators, spanning 1988 to 2013. They find a movement of employees between banks and the government that is based on the ebb-and-flow cycles associated with the sector. When the banking sector is under stress, regulators hire workers. But when banks are booming, they’re the ones hiring.
Moreover, rather than offering lax regulation in the hopes of a job, regulators who head to the private sector are more likely to be tougher on the companies they oversee in the time leading up to their career transition, according to the research. These banks could be simply hiring away the most-capable regulators, who make life difficult for the banks, to weaken government oversight, Seru says. “But companies also want to hire good people. If I’m a good regulator and you’re in the private sector, you hire me. There’s nothing wrong with that.”
The appeal of accuracy
Investment banks tend to hire ratings agencies’ better analysts.
Chicago Booth’s Elisabeth Kempf observes a somewhat similar trend in credit analysis. She finds that credit analysts who left for investment banks were more accurate than their peers, in the sense that they needed their ratings adjusted less. She says the data suggest analysts are hired away by companies because they produce more-accurate work, not as a reward for favors granted. There’s also some evidence that analysts perform better when investment banks are hiring more intensively, consistent with the idea that the revolving door may compel analysts to work harder.
There is evidence that the departing analysts were less accurate in one area: at the companies where they eventually went to work. But Kempf notes that there were few examples of analysts rating their soon-to-be employers. To her, the few examples of deficient work fail to negate the positive outcomes. “It seems to me that the benefits may outweigh the costs,” Kempf says. “On the one hand, you might want to help your future employer, but you also want to build your reputation.”
In a study of SEC lawyers, University of Washington’s Ed deHaan, Rutgers University’s Simi Kedia, Nanyang Technological University’s Kevin Koh, and Columbia University’s Shivaram Rajgopal find that lawyers who left the agency for private law firms were more aggressive than their peers, as evidenced by settlements. DeHaan says that instead of a quid pro quo, those lawyers fall under the human-capital hypothesis.
“They’re the most aggressive and get the toughest settlements,” deHaan says. “They’re signaling their talent. The law firms hire the best people from the SEC. By being excellent at their job, the SEC lawyers get jobs at these private law firms.”
The research findings, then, are far from settled. The finding that analysts and lawyers who left for industry performed better rather than worse puts it at odds with the research by Wollmann, who wonders if results are affected by whether a regulatory agency is privately or government run. Ratings agencies could go out of business if companies stop buying their reports, whereas government employees have no such market imperative. Meanwhile, Kempf says she finds it unlikely that companies are willing to hire less-qualified employees, even those that have been nice to the company.
While deHaan finds that lawyers who left the SEC were more aggressive with their cases, he says it’s also possible these attorneys cherry-picked cases that looked the easiest to win in order to bolster their résumés. Or they could have decided against prosecuting certain companies. Data on case selection and case appointment aren’t available.
“These are difficult issues to grapple with. It’s difficult to get empirical data to measure performance,” he says. “Opacity is the friend of corruption. And with the SEC in particular, we have a difficult time getting data on their enforcement processes.”
But the opposing findings demonstrate how challenging it is to draw policy conclusions, even though the suggestion of impropriety continues to inspire rules and orders. Several one-year bans, known as cooling-off periods, prevent some US federal employees from working in specific jobs for a year after leaving government. One specifically applies to SEC auditors. Other, stricter rules include lifetime bans on “switching sides,” or representing a private party in a matter in which the employee has previously represented the government. (Those rules apply to specific circumstances and affect few federal employees, allowing most government employees to freely take jobs in the private sector.)
US Senator Tammy Baldwin and Representative Elijah Cummings in July 2015 proposed the Financial Services Conflict of Interest Act, which would ban bonuses paid to private-sector employees who leave to work for the government; increase the lobbying ban to two years and expand the definition of lobbying, as well as which federal employees are covered; and force financial regulators to recuse themselves for two years on actions that would “directly or substantially benefit” former employers or clients. That proposal remains in committee.
The researchers caution that policies aimed at stopping or slowing the revolving door could have unintended consequences, for example by making it difficult for the government to attract talented employees. “In terms of financial regulators, a cooling-off period might be detrimental because you might be hurting their employment opportunities,” warns Kempf. Wollmann generally supports actions that seek to slow the revolving door, but he agrees that if the government attempts to draw legal expertise from only its own ranks, “you’re not going to have a large pool to draw from.” What are the consequences of letting it continue to spin? Time, and more evidence, will tell.
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