When to Step in: Timing Is Everything in Regulation
Regulation is about decisions—often high-stakes ones. Should regulators act preemptively to prevent harm, or wait to act until the consequences of a new business activity are clear? A recent study by Marco Ottaviani (Bocconi Department of Economics) and Abraham L. Wickelgren (University of Texas) in The Journal of Law, Economics, and Organization examines this timeless question, offering fresh insights into when pre-activity approval or post-activity adjustments lead to the best outcomes.
The digital age dilemma
Consider Facebook’s $19 billion acquisition of WhatsApp in 2014. Approved by regulators on both sides of the Atlantic, the merger was later criticized as evidence mounted that Facebook’s strategy was to squash competitors. By 2020, the U.S. Federal Trade Commission was suing Facebook for anti-competitive practices, including earlier acquisitions like Instagram. Such cases highlight the core challenge explored in this study: regulators must often decide without knowing all the facts, but undoing decisions later can be costly—and sometimes impossible.
The key questions
Ottaviani and Wickelgren’s research seeks to determine when regulators should commit to pre-activity approval and avoid post-activity interference. It also investigates how the threat of post-activity reversal influences businesses’ behavior and examines the role irreversibility costs—such as the difficulty of undoing a merger, project, or product—play in regulatory strategy.
Their analysis reveals that striking the right balance is an art as much as a science. “The level of uncertainty at the time of decision-making is critical,” Ottaviani argues. “In fast-moving industries like tech, it’s often impossible to predict future harms—or benefits—with precision.”
A balancing act
The study highlights two major effects of ex post regulation. On one hand, the “discipline effect” ensures that companies align their strategies more closely with societal welfare, knowing that their actions will be scrutinized. Facebook’s efforts to curb misinformation on WhatsApp, for instance, might be seen as an attempt to gain goodwill from regulators. On the other hand, there is a “chilling effect,” where businesses hesitate to pursue socially valuable projects due to fear of costly reversals. Without regulatory commitment, the study warns, beneficial activities may be left unrealized.
Real-world applications
These insights find applications across multiple industries. In merger control, regulatory errors made during the ex ante stage can have outsized consequences. Approvals like Facebook’s acquisitions, based on incomplete knowledge of competitive effects, highlight how difficult it is to reverse such decisions. Environmental regulation faces similar dilemmas. Blocking an oil drilling project in a sensitive area avoids potential risks but foregoes the benefits that might arise from the activity. Allowing the project to proceed with an option to shut it down later introduces flexibility—provided reversal costs aren’t prohibitively high. Consumer protection also benefits from this framework. For instance, financial products designed for sophisticated investors but marketed to the general public can be evaluated post-approval to better understand their societal impact.
The role of irreversibility
A particularly fascinating insight from the study is how businesses can manipulate the cost of reversal. Companies might deliberately increase irreversibility—for instance, by integrating platforms post-merger—to make regulatory intervention more difficult. This manipulation strengthens the case for preemptive action in cases where such tactics could create insurmountable obstacles for regulators.
Recommendations for regulators
The study emphasizes the need for a tailored approach to regulation. Regulators should evaluate the level of uncertainty at the approval stage, weigh the costs of reversing a decision against the consequences of a bad approval, and remain vigilant about businesses’ attempts to game the system by manipulating irreversibility. In digital markets, where uncertainty and irreversibility costs are particularly high, the authors suggest favoring ex ante regulation. Conversely, industries that allow for learning through observed outcomes and have low reversal costs may benefit more from ex post flexibility.
Regulation is rarely clear-cut, but as Ottaviani and Wickelgren demonstrate, it can be strategic. Their work offers lessons for policymakers navigating the murky waters of modern economies. The stakes couldn’t be higher: get it wrong, and society bears the cost for decades. But with the right tools and frameworks, regulators can balance innovation and accountability, reaping the benefits of progress while safeguarding the public good.
