Independence, Investment and Political Interference: Evidence from the European Union

This paper examines the implications of “modern” regulatory governance – i.e. the inception of
Independent Regulatory Authorities (IRAs) – for the investment decisions of a large sample of EU
publicly traded regulated firms from 1994 to 2004. These firms provide massively consumed services,
and this is why governments are highly sensitive to regulatory decisions and outcomes. We therefore
analyse and empirically investigate if: i) the inception of IRAs reduces the time-inconsistency
problems that lead regulated firms to underinvest, and ii) governments’ political orientation and
residual state ownership interfere with investment decisions. To control for potential endogeneity of
the key institutional variables, we draw our identification strategy from the political economy
literature. Our results show that regulatory independence has a positive impact on regulated firms’
investment while private vs. state ownership is not significant. We also find that, under executives at
the extreme of the political spectrum, government interference in the functioning of the IRA is likely
to re-introduce instability and uncertainty in the regulatory framework, thus undermining investment
incentives.