Business & Government Relations Final Study Guide Part 1 CH 10-13 & Practice Questions
Business & Government Relations Final Study Guide Part 1 CH 10-13 & Practice Questions BADM 3102
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Business and Government Relations Study Guide II: Chapters 1013 & Questions Chapter 10: Regulation: Law, Economics, and Politics Introduction ● Regulation takes place through a public process that is relatively open and allows participation by interested parties ● Regulatory decisions and rulemaking proceedings are extremely important to many firms, industries, and interest groups Set of Interventions ● Controlling prices ● Setting floor prices ● Ensuring equal opportunity ● Regularizing employment practices ● Specifying qualifications ● Providing for solvency ● Controlling the number of market participants ● Limiting ownership ● Requiring premarketing approval ● Ensuring product safety ● Mandating product characteristics and technology ● Establishing service territories ● Establishing performance standards ● Controlling toxic emissions and other pollutants ● Specifying industry boundaries ● Allocating public resources ● Establishing technical standards ● Controlling unfair international trade practices ● Providing information ● Rationing common pool resources ● Protecting consumers ● Controlling risks Periods of Regulatory Reform ● Four major periods of regulatory change ○ Populist era (late 1800s) ○ Progressive era and the New Deal ○ Social regulation (began in the 1960s) ○ Economic deregulation (began in the 1970s) The Constitutional Basis for Regulation ● The U.S. Constitution not only provides the authority for regulation ○ It also limits its application ● Many legal principles of regulation in the United States have come from court decisions that draw on the common law ● The Fifth and Fourteenth Amendments place limits on regulation Principal Federal Regulatory Agencies and Commissions Delegation, Rulemaking, Due Process, and Discretion ● Article I, Section 1 of the Constitution grants Congress the sole power to enact laws ● Congress enacted the Administrative Procedure Act (APA) of 1946 to: ○ Provide for public notice and comment prior to agency action ■ Agencies adopt their own rulemaking procedures in a manner consistent with the APA ● The APA grants parties right to sue for judicial review of an agency action ○ A basis for that review is failure to follow the procedures required for an action ■ Under the framework of procedural due process ● The APA requires: ○ Agency actions not be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law” ● The courts review regulatory actions for whether they are arbitrary or capricious Influences on Regulatory Agencies Market Imperfections •Natural monopoly •Externalities •Public goods •Asymmetric information Government Imperfections ● Market imperfections warrant government regulation ○ Only a necessary condition for regulation to improve economic efficiency Capture Theory ● Predicts that regulation initially will be found where there are market imperfections and over time will evolve to serve the interests of the regulated industry RentSeeking Theory ● Regulation not established to address market imperfections ○ Instead, it is established to benefit politically effective interests Fairness ● Regulation used to accomplish fairness goals ● Can involve policies such as: ○ Lifeline rates for telephone service for lowincome people ○ The provision of aid such as food stamps CostofService Theory ● Regulation in a number of industries has centered on costofservice pricing ● This costofservice regulatory system has been blamed for inducing high costs and slowing the introduction of new technology. Chapter 11: Financial Markets and Their Regulation Introduction ● The capital markets are an essential component of a capitalist economic system that allow individuals to ○ Save their money in a broad array of financial instruments ○ Transform those savings into funding for businesses, homebuying, and retirement The Formal and Informal Banking Systems ● Depository institutions such as banks accept deposits and make loans ○ These institutions are required to maintain a fractional reserve requirement ■ Allows the formal banking system to lend a multiple of the deposits held Repurchase Agreement “Shadow Banking” System ● Operates outside the purview of regulators ○ Provides much of the financing for banks, securities traders, and mortgage lenders ● Securitization Involves pooling contractual debt obligations and issuing new securities backed by those obligations ○ A component of the shadow banking system Collateralized Debt Obligations Credit Default Swap The Federal Reserve System ● Established in 1913 ● Serves as the central bank of the United States ● Has broad responsibilities for managing the money supply ● Has regulatory authority over national banks and state banks that participate in the Federal Reserve System Securities Regulation ● The first New Deal legislation enacted was the Securities Act of 1933 ○ Regulated the issuance of new securities ● In 1934, Congress enacted the Securities Exchange Act to: ○ Extend regulation to stock exchanges and the trading of alreadyissued securities ● GlassSteagall Act of 1933 ○ Forced banks to separate their commercial banking and investment banking businesses ○ Later repealed by the GrammLeachBliley Act of 1999 Credit Card Regulation ● Credit CARD (Card Accountability Responsibility and Disclosure) Act of 2009 ○ Increases the regulation of credit card issuers ● Regulations intended to eliminate abuses can have effects on markets Mortgage Lending and Subprime Mortgages ● Mortgage lending had been dominated by banks and savings and loans associations ● Lenders held some of the mortgages they originated and sold the rest to: ○ Governmentsponsored enterprises ○ Federal National Mortgage Association (Fannie Mae) ○ Federal Home Loan Mortgage Corporation (Freddie Mac) ● The Federal Housing Administration (FHA) provided financing for qualified borrowers ○ Government policy supported expanding home ownership through government support of Fannie Mae, Freddie Mac, and the FHA Financial Crisis Inquiry Commission ● Principal conclusions of the majority: ○ It was avoidable ○ Widespread failures in financial regulation and supervision ○ Dramatic failures of corporate governance and risk management at many systemically important financial institutions ○ Excessive borrowing, risky investments, and lack of transparency ○ Inconsistent response of an ill prepared government ○ Collapsing mortgagelending standards and the mortgage securitization pipeline ○ Overthecounter derivatives contributed significantly ○ Failures of the credit rating agencies were essential cogs in the wheel of financial destruction ● 10 essential causes identified by the dissenters: ○ Credit bubble ○ Housing bubble ○ Nontraditional mortgages ○ Credit ratings and securitization ○ Financial institutions concentrated correlated risks ○ Leverage and liquidity risk ○ Risk of contagion ○ Common shock (the fall in housing prices) ○ Financial shock and panic ○ Financial crisis causes economic crisis TARP, Bailouts, and the Stimulus ● The Bush administration and Congress created the Troubled Asset Relief Program (TARP) ○ Administered by the Department of the Treasury ○ Authorized with funding up to $700 billion to be used to shore up banks and stimulate the provision of credit to borrowers The DoddFrank Wall Street Reform and Consumer Protection Act ● DoddFrank Act ○ Provided for new regulations ○ Strengthened enforcement ○ Required new rule making by regulators ○ Created a new regulatory agency The Consumer Financial Protection Bureau ○ Restricted the pricing of credit card borrowings ○ Increased the exposure of credit rating agencies to lawsuits ○ Restricted securities trading by banks ○ Required derivatives trades to go through clearinghouses ○ Imposed new capital requirements on banks ○ Did not address the roles of Fannie Mae and Freddie Mac Financial Stability Oversight Council ● Established by the DoddFrank Act ● Composed of the heads of 10 regulatory agencies with responsibility for: ○ Monitoring the economy ○ Responding to emergencies that threaten the stability of the financial system Too Big to Fail ● The Act: ○ Authorized the government to seize and break up a firm whose collapse could result in substantial harm to the economy ○ Required financial companies to develop “living wills” for closing down and provided for the orderly liquidation of failed companies The Volcker Rule ● Included in the DoddFrank Act after heated debate ○ Subsequently subject to extensive rulemaking activity to refine the restrictions ● Allowed banks to trade on behalf of clients and to hedge their own risks Derivatives and Swaps ● To reduce risks and increase regulatory scrutiny: ○ The Act gave the Commodities and Futures Trading Commission (CFTC) regulatory authority over swaps and major swap market participants such as marketmakers Securitization and Excessive Risks ● Issuers of assetbacked securities were required to retain: ○ At least 5 percent of the risk unless the assets meet certain loan standards Consumer Protection ● Complaints from consumers and consumer advocacy groups about financial products centered on: ○ Abusive mortgages ○ High interest rates charged by payday lenders ○ Financing practices of automobile dealers and student loan companies ● The DoddFrank Act created a Consumer Financial Protection Bureau (CFPB) ○ Has authority over: ■ Banks with assets over $10 billion ■ Mortgage lenders ■ Student loan companies ■ Payday lenders Compensation ● The DoddFrank Act directed the SEC to address the compensation issue ● The SEC: ○ Promulgated “say on pay” rules requiring a nonbinding shareholder vote on executive compensation at least every 3 years ○ Proposed rules requiring banks and financial services firms to: ■ Report bonuses paid to individual employees ■ Block bonuses that posed the risk of “material financial loss” for the firm Credit Ranging Agencies ● Provide information to investors about risks associated with securities ● Government regulators have delegated to designated Nationally Recognized Statistical Rating Organizations (NRSRO) the assessment of risks associated with securities. Global Capital Requirements Regulation Basel III ● Basel Committee on Banking Supervision An organization of 27 nations that sets capital requirements for banks ○ Requirements must be approved by the G20 nations ■ Enacted into law by each nation Chapter 12: Environmental Management and Sustainability Introduction ● Public, government, and businesses recognize the importance of environmental protection and sustainability ● Benefits include: ○ Improved human health ○ A more vibrant natural environment ○ The preservation of ecosystems ○ A more sustainable relationship with the natural environment The Environment and Sustainability ● Goals and action ● Global climate change ● Policy ● Tradeoffs Socially Efficient Control of Externalities ● The control of externalities has taken the form of commandandcontrol regulation ● Incentive approaches Take into account the benefits and costs of attaining environmental objectives ○ Achieves those objectives by aligning the social and private costs of pollution and its abatement The Coase Theorum ● Pertains to market imperfections, including externalities and public goods ● Focuses on the standard of social efficiency ● Provide s a conceptual foundation for both regulation and the liability system Transaction Costs and the Limits of the Coase Theorem ● The Coase theorem implies that: ○ When bargaining between the parties to an externality is possible, social efficiency can be achieved CapandTrade Systems ● Caps the total allowed emissions of a particular pollutant, issues permits (entitlements) for that amount, and allows the permits to be traded ○ Also called tradable permits systems Global Climate Change and Emissions Trading Systems ● Kyoto Protocol ● Emissions trading in the European Union ● The Regional Greenhouse Gas Initiative (RGGI) ● Emissions trading Within BP plc (British Petroleum) Kyoto Protocol ● Accomplishments under the Kyoto Protocol a subject of disagreement ○ Developed countries have reduced their domestic emissions ■ Research shows that this is due to increased imports displacing local production Emissions Trading in the European Union ● The European Union took the lead on multination emission ○ Traded with the European Trading System (ETS) commencing in 2005 ● ETS is a capandtrade system that covers 12,000 facilities in 15 EU member states ○ The EU goal was an 8 percent reduction by 2012 from a 1990 base Emissions Trading Within BP PLC (British Petroleum) ● To address the global climate change issue: ○ In 1998 BP plc committed by 2010 to reduce its emissions of greenhouse gases (GHGs) by 10 percent from 1990 levels ● To achieve its goal, BP worked with Environmental Defense to develop an internal GHGs trading system for the company The Regional Greenhouse Gas Initiative ● Formed in 2005 by 10 northeastern U.S. states ○ To operate a capandtrade system for reducing greenhouse gases emissions ○ Auctioned 86 percent of the allowances generating $790 million through 2010 ● Supported by companies that benefited from the funds generated by the auctions ○ Other companies argued that it drove up costs and drove jobs away The Environmental Protection Agency (EPA) ● An independent agency located in the executive branch ● Headed by an administrator appointed by the president and confirmed by the Senate ● Responsible for administering the major environmental acts Enforcement ● The EPA enforcement process requires: ○ Filing of a notice of a complaint and a hearing before an administrative law judge Standards Setting and Engineering Control ● EPA regulation has largely been command and control ○ Uniform rules or standards are ordered and then enforced ● The EPA sets emissions standards and air quality standards ● EPA has increasingly used incentive approaches: ○ Credits and offsets Superfund ● Administered by the EPA ○ For the cleanup of existing toxic waste disposal sites ● EPA attempts to identify the source of the dumping and force it to clean the site The Nature of Environmental Politics ● Environmental issues are complex because of: ○ Scientific uncertainty about the consequences of pollution ○ Incomplete information about the costs and benefits of environmental protection ○ Disagreements about alternative approaches, such as liability versus regulation, to protection ○ Differing perspectives about the protection of entitlements Judicial Politics ● Politics of environmental protection often moves into judicial arenas ● Environmental groups have succeeded in inserting citizen provisions in environmental statutes Advocacy Science ● Much remains unknown about environmental hazards and their control ○ This scientific uncertainty is a source of contention in environmental politics ○ It provides an opportunity to use advocacy science as a component of a private politics strategy Distributive Politics ● Environmental politics is motivated by: ○ Distributive consequences of environmental policy ○ Costs of environmental protection ○ Benefits from the reduction in pollution and hazards Private and Public Politics ● Many environmental NGOs active in public politics at the federal, state, and local levels ● Environmental groups testify regularly in legislative and regulatory hearings ○ Some demonstrate to attract media coverage to their side of the issue NIMBY and Private Politics ● NIMBY “Not in mybackyard” ○ Focuses on local environmental concerns, particularly as they involve possible risks to persons or property ○ Directed toward: Refuse disposal & toxic waste sites, chemical & oil plants, other facilities that may emit toxins ● Energized by information provided by the federal government’s Toxics Release Inventory (TRI) ● The TRI is a result of the “righttoknow” amendment to a 1985 Superfund reauthorization bill Voluntary Collective Environmental Programs ● ISO 14001 ● Responsible Care program ● Criticisms of Voluntary Programs ○ Called “greenwash” by environmental groups ○ Allege that these programs sound good to the public ○ Fail to live up to their promises Chapter 13: The Investor’s Perspective: Renewable Energy Introduction ● Managing effectively in the nonmarket environment is essential for firms when: ○ A company is at a major strategic crossroad ○ There are market or nonmarket challenges ● Strategy implementation is essential on an ongoing basis at an operational level to: ○ Achieve performance goals ○ Address challenges ○ Seize opportunities Investment Decisions ● In making their decisions, investors assess: ○ Opportunities and risks associated with firms ○ Quality of their management ● The assessment of managerial quality depends on: ○ A firm’s leadership and market strategy ○ A firm's nonmarket strategy ○ The ability of management to anticipate and deal effectively with the emergence and development of nonmarket issues The Environment of Wind and Solar Power ● Longterm opportunities for wind and solar power were enormous ○ Supply costs were falling ○ Demand for renewable power was expected to continue to grow ○ Demand growth had been led by Europe as a result of generous subsidies ■ As the subsidies were reduced, growth slowed ○ At the same time demand grew in China and the United States ■ More countries began to support wind and solar power ○ Demand was expected to grow substantially in China and developing nations ● Growth hinged on government support and the cost of other energy sources Markets and Government Involvement ● Retail electricity prices varied greatly across the states ○ Both solar and wind power were quite variable ■ Solar power output depended on the weather ■ Wind power was most attractive in locations where the wind blows hard and steadily ○ Solar/wind power faced nonmarket opposition because of: ■ The cost of subsidization ■ Environmental NIMBY Market Signal ● Market for solar panels in Europe and the United States slowed to a crawl in 2010 ○ Market in China grew at a rapid pace Economic Rationale for Subsidization ● Economic rationales for the subsidization of renewable power: ○ Based on positive externalities ■ Subsidization provides environmental improvements by displacing carbonbased power generated from coal or natural gas ■ Subsidization provides security benefits to the extent that it reduced the dependence on imported fuels ○ Intended to achieve cost efficiencies and increased output ■ Subsidies could enable producers to realize economies of scale that would reduce costs and allow output to expand Political Rationale for Subsidization ● Positive externalities for the environment and security benefitted constituents ● Subsidization generated pork: ○ Recipients of the subsidies and their suppliers earned rents from the economic activity stimulated by the subsidization The Costs of Subsidization ● Direct costs of subsidies are the corresponding government budget expenditures and liabilities ○ Examples Grants and loan guaranties Solyndra Inc ● In 2008 Solyndra and Solar Power, Inc., a leading installer of solar panels, agreed to a supply arrangement for $325 million of solar panels over the 2008–2012 period ● Market risks: Prices and costs ● Non Market risks *Solar Power Opportunities and Risks—Market and Nonmarket Factors Practice Questions Ch. 1013 True/False 1. When there are market imperfections, government intervention can improve its efficiency. TRUE/ FALSE 2. Congress mandates that regulatory agencies provide for public notice and comment prior to agency action. TRUE/ FALSE 3. Interested parties such as firms are prohibited from participating in formal and informal rule making proceedings. TRUE/ FALSE 4. Regulation in the US takes place through a private process that is closed and lowprofile. TRUE/ FALSE 5. With the disintegration of the mortgage market, lenders do not bear the risk of failure of borrowers to repay loans. TRUE/FALSE 6. Securitization involves pooling contractual debt obligations and issuing new securities backed by those obligations. TRUE/FALSE 7. Securitization can reduce idiosyncratic risks but cannot reduce systematic risks. TRUE/FALSE 8. Commandandcontrol regulation imposes uniform controls and standards on dissimilar sources of pollution. TRUE/FALSE 9. The Coase theorem implies that a negative externality can be resolved when property rights are assigned to the pollutees, not the polluters. TRUE/FALSE 10. The Coase theorem implies that when bargaining between two parties to an externality is possible, social efficiency can be achieved. TRUE/FALSE 11. Voluntary environmental information disclosure by firms provides an accurate representation of their environmental performance. TRUE/FALSE 12. Renewable energy (non hydroelectric) production has been dependent on subsidies because it is not cost competitive. TRUE/FALSE 13. The U.S. government provided subsidization on both the demand and supply sides of the market for renewable power. TRUE/FALSE 14. The NIMBY movement can hamper the development of renewable energy. TRUE/FALSE Multiple Choice 1. GlObedOt is a leading manufacturer of information display systems based in California. It seeks uniform federal regulation to impose a carbon emission tax on all manufacturing firms. This is an example of ________. a. natural monopoly b. rentseeking theory c. adverse selection d. moral hazard 2. Which of the following regulatory approach has been blamed for inducing inefficiency across companies? a. Deregulation b. CostofService regulation c. Information disclosure requirement d. Monopoly restrictions 3. In constructing CDOs, the mortgage loans are sliced into tranches with the cash flowing first to the _____. a. most safe tranche (lowest interest rate) b. most risky tranche (highest interest rate) c. noninvestment grade tranche 4. Which of the following did not contribute to the financial crisis of 20072008? a. Subprime lending b. High leverage ratio for banks c. Credit default swaps d. Regulation of derivatives 5. The regulatory responses to the financial crisis include all of the following except a. penalizing customers who defaulted on interest payments b. increasing the regulation of credit card issuers c. .reducing speculative investments by banks d. .regulating credit rating agencies 6. ________ have become an effective means of achieving environmental goals at the least cost to society. a. Commandandcontrol regulations b. Incentivebased regulations c. Costofservice regulations d. Voluntary approaches 7. Why were the loan guarantee and cash option awarded to renewable power producers jeopardized? a. .State public utility regulatory agencies were barred by law from determining renewable energy prices. b. The huge federal budget deficit required measures to reduce expenditure. c. State public utility regulatory agencies gave a negligible premium for renewable power. d. The price of natural gas rose considerably. Short Answers •What are alternative theories to explain where regulation is or is not imposed? •Under what circumstances does the market fail to function properly and government intervention is justified? •Explain commandandcontrol vs. incentivebased approach to environmental regulation. •Explain the basics of emissions trading scheme. •Explain two nonmarket factors that encourage investment in renewable energy. •Explain two nonmarket factors that discourage investment in renewable energy. Answer Key True/False 1. T 2. T 3. F 4. F 5. T 6. T 7. T 8. T 9. F 10. T 11. F 12. T 13. T 14. T Multiple Choice 1. B 2. B 3. A 4. D 5. A 6. B 7. B
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