The Effect of Regulatory Constraints on Firm Innovation: The Role of Moderators

Ephrat Segev 2008

Introduction A lot of Studies have been conducted regarding the various influences

of regulations on firm performance; however none has taken under consideration many inner and outer variables such as firm size or costumer orientation. A different aspect of regulation is tested, not as a constraining hazard

to a firm, but as a catalyst to product innovation and improvement that can lead to an improved performance, both profitability wise and market share wise. An empirical research that examines the effect of regulations on firm

performance using data on food products in the US that were subjected to labeling regulation during the 90's.

Literature Review The concept of a constraint can be defined as a condition that limits firm abd prevents it from fully achieving its goal. Constraints can be internal, such as manpower, liquidity or credit difficulty or problematic organizational structure. There can also be external constraints such as economic depression or other kinds of environmental chages. An organization can face several kinds of constrains, with firm constrains as major source of difficulty and challenge. A key factor in firm constrains is product regulation and government legislation (here: regulation). Regulation and government legislation have recently become a great influence over entire markets and lines of products, including tobacco, pharmaceuticals, food

products and environmentally related products such as automobiles. Over the recent years, product regulation and especially environmental regulation has become a key determinant in a firm's decision to change its environmental approach. The hypothesis that environmental regulation represents a main determinant of managerial concerns has been tested empirically by Henriques and Sadorsky (1996). They found that while there are various kinds of pressure that can be implied on a firm regarding its products such as competitors or consumer pressure, government regulation represents the single most important source of pressure on a firm, obliging it to change, improve itself or replace its products. It is yet to be determined whether constraining conditions have a sole negative effect on firm performance. There is a long discussion over the long and short term effects of constraining regulation on firm performance. The majority of researchers claim that regulation has a negative effect over firm performance, especially small and medium enterprises. It has been argued that costly and onerous regulations, such as those of the U.S food and drug administration (FDA) may cause severe deterioration in the research productivity of food manufacturers and pharmaceutical companies. Although the contribution of regulation to the deterioration of the research and development (R&D) expenditures is controversial, the fact that regulation had a negative impact on firm innovation and performance was unequivocal (. Many researchers have demonstrated the negative effect regulation has on firm innovation and performance. Small firms was shown to be the ones most damaged by a new regulation, due to liquidity constraints, lack of resources, and relatively high R&D costs (Thomas, 1990). Moreover, Furthermore, Musso and Schiavo (2008) claimed that financial regulatory constraints significantly increase the probability of exiting the market. Regulation has also been found to decrease entrepreneurship

inside a firm. Regulatory business costs were found to deter opportunity driven entrepreneurship.

Some research has shown that regulatory constraints have a negative effect on firm performance (Birnbaum, 1984). Few researchers have demonstrated a positive effect between them (Leonard, 1984, Bartel and Thomas, 1987). This inconsistency can be explained by the fact that most of the models describe a simple one-way relationship between regulation and firm performance, and do not take account of the contingency effects of contextual variables, such as competitors, firm size or product specialization.

Henriques, L and P. Sadorsky (1996) "The determinants of an environmentally responsive firm: An empirical approach", Journal of Environmental Economics and Management, 30. pp. 381-395. Rugman, A. and Verbeke, A (1998). "Corporate Strategies and Environmental Regulations: An Organizing Framework" Strategic Management Journal, 19(4) pp 363-375. Thomas, L.G (1990) "Regulation and firm size: FDA impacts in innovation", RAND Journal of Economics, 21(4) pp. 497-518. Patrick Musso, Stefano Schiavo. (2008). The impact of financial constraints on firm survival and growth. Journal of Evolutionary Economics, 18(2), 135-149. Retrieved July 26, 2008, from ABI/INFORM Global database. (Document ID: 1469101131).

Yuen-Ping Ho, Poh-Kam Wong. (2007). Financing, Regulatory Costs and Entrepreneurial Propensity. Small Business Economics, 28(2-3), 187. Retrieved July 26, 2008, from ABI/INFORM Global database. (Document ID: 1228014381).