Why Do Regulatory Firms Sometimes Underperform?

An organization's performance relies on its members' effective execution of tasks aligned with its goals and purpose. For private third-party regulatory firms—for-profit companies that enforce and monitor regulatory compliance—organizational goals aim to generate and capture economic value by safeguarding stakeholders and the public interest.

In a new study, “Mitigating Ingroup Bias in Regulatory Firms: The Role of Inspector Professionalism,” researchers considered ingroup bias to examine why regulatory firms sometimes underperform in their duties; they also looked at the effect of inspectors’ professionalism. The study uncovered evidence of ingroup bias and found that inspectors’ professionalism lessens the effect of that bias on the stringency of regulatory enforcement.

The study, by researchers at Carnegie Mellon University and the University of Toronto, is published in Strategic Management Journal.

“We sought to determine whether the under-explored mechanism of ingroup bias can lead regulatory agents to grant unwarranted trust to ingroup clients with whom they share significant characteristics, resulting in less rigorous inspections for these clients than for others,” explains Sunkee Lee, Associate Professor of Organizational Theory and Strategy at Carnegie Mellon’s Tepper School of Business, who coauthored the study.

Third-party regulatory firms include accounting firms that audit companies’ financials; social auditors that monitor violations related to issues such as child labor, occupational safety, and pollution; and car facilities that conduct emissions testing. When regulatory organizations are negligent, they expose society to financial, environmental, social, and safety risks.

In this study, in addition to exploring bias, researchers considered a mechanism based on human capital—professionalism, or individuals’ sense of oneness with their profession and internalization of professional norms and standards. Since the regulatory profession values objectivity and impartiality, could an individual regulatory agent’s professionalism replace the implicit trust resulting from shared group membership—a core mechanism that drives ingroup bias—with adherence to professional standards, resulting in a more uniform application of regulations across entities?

Researchers used naturally occurring data from an established private third-party regulatory firm that conducts portside inspections for marine vessels and cargo in the maritime sector, tracking 86 inspectors across 24,650 inspections of 462 vessels. Individual agents employed by the firm were responsible for inspecting vessels to ensure compliance with globally established standards. Domestic clients were considered the ingroup and foreign clients the outgroup.

The study found compelling evidence of ingroup bias, which was based on nationality.  Regulatory agents, all domestic nationals, were on average less rigorous in their inspections of domestic clients than of foreign clients. The bias persisted until a large-scale maritime accident, which reduced implicit trust for ingroup clients and led to inspections of ingroup clients becoming disproportionately more stringent than those for outgroup clients.

Inspectors’ levels of professionalism moderated their susceptibility to this bias. Inspectors with higher levels of professionalism enforced regulations uniformly with domestic and foreign clients, while inspectors with lower levels of professionalism were more lenient toward domestic clients. Following the accident, inspectors with less professionalism drove a correction in inspection behavior, becoming more stringent in their work.

Regulatory agents did not need economic motivations or pre-existing relationships with the regulated entity for regulatory failure to happen, say the authors. Rather, salient and contrasting characteristics among regulated entities appeared sufficient to trigger favorable biases toward the group of regulated entities with whom regulatory agents more closely identified. Regulatory organizations need to consider the social dynamics and professionalism of regulatory agents to ensure that regulations are enforced stringently and impartially to alleviate regulatory failure, the authors conclude. The fact that national identity can serve as a bias in business and impede performance may increase as society moves toward a more anti-globalist and pro-nationalist stance all over the world.

“Our findings highlight the distinctive nature of ingroup bias in regulatory entities’ performance and help us understand how considerations related to human capital may influence these organizations’ ability to uphold impartiality,” says Oliver Hahl, Associate Professor of Organizational Theory, Strategy, and Entrepreneurship at Carnegie Mellon’s Tepper School of Business, who coauthored the study.

Among the study’s limitations, the authors note that their work was with a single firm in one geographic region, so it is unclear whether the findings generalize to other firms in other settings. In addition, the study assumed that longer inspection times meant more stringent and effective regulatory practices; this may not hold across all regulatory settings.

“Although we studied a private third-party organization with regulatory authority, our theorizing and the implications of our findings likely extend to a wide range of regulatory entities since psychological tendencies associated with ingroup bias can manifest across diverse regulatory settings,” adds Sae-Seul Park, coauthor, Tepper School PhD alum, and Assistant Professor of Strategic Management at the University of Toronto’s Rotman School of Management.

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Summarized from an article in Strategic Management Journal, Mitigating Ingroup Bias in Regulatory Firms: The Role of Inspector Professionalism, by Park, S-S (University of Toronto), Lee, S (Carnegie Mellon University), and Hahl, O (Carnegie Mellon University). Copyright 2025 The Authors. All rights reserved.