Who captures whom? Regulatory misperceptions and the timing of cognitive capture

Rilinger, Georg Article — Published Version Who captures whom? Regulatory misperceptions and the timing of cognitive capture Regulation & Governance Provided in Cooperation with: John Wiley & Sons Suggested Citation: Rilinger, Georg (2021) : Who captures whom? Regulatory misperceptions and the timing of cognitive capture, Regulation & Governance, ISSN 1748-5991, John Wiley & Sons Australia, Ltd, Melbourne, Vol. 17, Iss. 1, pp. 43-60, https://doi.org/10.1111/rego.12438 This Version is available at: https://hdl.handle.net/10419/287933 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Regulatory misperceptions and the timing of cognitive capture Georg Rilinger Max Planck Institute for the Study of Societies, Paulstr. 3, Köln, 50676, Germany Abstract To explain cognitive capture, economic sociologists often examine the structure of relationships between regulators and market participants. This paper argues that the nature of regulators’misperception should be subject to analysis as well. Different types of misperceptions develop over timelines of varying lengths. Depending on the misperception, different sets of relationships and parties may therefore be the cause of regulators’capture. The paper illustrates this point with a case study of regulators’failure to detect pervasive market power in California’s electricity markets between 1998 and 2001. Existing explanations focus on sellers’short-term attempts to distract regulators from widespread evidence of market power. Using data from three archives and in-depth interviews, I show that the regulators did not fall prey to such “information problems.” Instead, their misperception resulted from a more foundational “worldview problem.”This error affects regulators’basic conception of the marketplace and can be traced to earlier and more gradual forms of influence exerted by utilities that, ironically, would become the victims of market power. Keywords: California energy crisis, cognitive capture, economic sociology, regulatory capture, regulatory dialectic. 1. Introduction Regulatory frameworks are constitutive for markets’functioning and stability. Such frameworks are not static but evolve dynamically. Industry participants react reflexively to rules and regulations. In turn, regulators reflect on the behavior of market participants and amend regulations accordingly. This process is often referred to as “regulatory dialectic”(Funk & Hirschman 2014; Kane 1977, pp. 55–56) because regulation and markets co-evolve in an iterative process of mutual observation and adaptation (Edelman & Stryker 2005, pp. 534–535; Silbey 2013, p. 11). In recent years, sociologists have increasingly studied why regulators fall behind in this process. Studies ask how rule avoidance becomes prevalent and why regulators fail to adjust regulatory frameworks to it (Lounsbury & Hirsch 2010; Wansleben & Walter 2019). In this paper, I focus on explanations that invoke regulatory capture. These explanations can be contrasted with work that looks at organizational and structural determinants (MacKenzie 2011). Instead, capture explanations examine regulatory interactions to determine specific culprits. They want to know who captured whom. The theory has been applied by journalists (Appelbaum & Nakashima 2008), economists (Dal B o2006), and legal scholars (Barkow 2010). Although sociologists and political scientists often prefer systemic explanations, work on regulatory dialectic has also entertained capture hypotheses (Lounsbury & Hirsch 2010; Seabrooke & Tsingou 2021). The theory has two versions. Material capture is substantially similar to corruption and refers to situations in which regulators “sell”desired policies to special interests to the detriment of the public interest (Carpenter & Moss 2013). Because this imposes a high burden of proof, the more typical form of capture is “cognitive”capture. It refers to situations in which regulators come to adopt the perspective of those they are supposed to regulate. In contrast to material capture, regulators do their best but fail to recognize problematic behavior. 1 Correspondence:Georg Rilinger, Max Planck Institute for the Study of Societies, Paulstr. 3, 50676 Köln, Germany. Email: [email protected] *Conflict of interest: There has been no conflict of interest in writing this article. Accepted for publication 31 August 2021. © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd. This is an open access article under the terms of the Creative Commons Attribution-NonCommercial License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited and is not used for commercial purposes. Regulation & Governance (2023) 17, 43–60 doi:10.1111/rego.12438 Although there is extant research on the social foundations of such misperceptions (Baker 2010; Fligstein & Goldstein 2010,2012), the literature has only begun to explore when and how cognitive capture takes place. Most arguments invoke homophily: regulators adopt the perspective of those who are similar –or close –to them in some way (Kwak 2013). In this paper, I argue that theories of cognitive capture should also pay attention to the temporal dynamics of regulators’epistemic problems. To determine who captured whom, it is crucial to know when the decisive influence took place. But not all regulatory misperceptions evolve over the same time horizons. Some evolve over long periods, while others emerge in the short term. To understand the timing of cognitive capture and identify the relevant relationships, it is therefore necessary to analyze the temporal structure of misperceptions that prevent regulators from detecting problematic behavior. Here, I distinguish two types. Regulators face information problems when those in charge do not receive, or fail to notice, crucial evidence of problematic behavior. In contrast, worldview problems occur when regulators’ background understanding of the market environment is flawed on the level of institutional practices or legal standards. In that case, regulators receive the right information, but they fail to understand its significance. Drawing on recent studies about the regulatory dialectic (Thiemann & Lepoutre 2017; Wansleben 2018), and the sociology of law (Edelman et al.2011; Gray & Silbey 2014), I show that these two problems correspond to capture mechanisms with different temporal trajectories. While information problems tend to be based on shortterm dynamics of deception and secrecy (Gibson 2014; Rilinger 2019), worldview problems tend to result from more gradual influences on the legal (Carruthers 2013) and the institutional structure (Wansleben 2021) that undergird the regulatory dialectic. Because each misperception is associated with different mechanisms of capture, close attention to the nature and origin of the misperception might reveal different culprits. In the empirical analysis, I illustrate this argument with a case study of regulatory failure during the creation and subsequent collapse of California’s electricity markets. Between 1998 and 2001, the Federal Energy Regulatory Commission (FERC) did not detect widespread market-power potential in California. FERC defined market power as a situation “[…] when the seller can significantly influence price in the market by withholding service and excluding competitors for a significant period of time.” 2 Starting in April 2000, precisely such opportunities emerged constantly and enabled dozens of sellers of wholesale electricity to drive up prices in California’s markets. This contributed to the Western Energy Crisis, which lasted for almost a year and pushed the electricity system to the brink of collapse. Until the beginning of 2001, FERC attributed the price spikes in California to genuine supply shortages. Despite repeated and increasingly urgent pleas from California, the agency refused to intervene even as prices skyrocketed (Joskow 2001; Taylor et al.2015). FERC’s recalcitrance in the face of crisis poses the empirical question this paper investigates: Why did FERC fail to detect the substantial levels of market power in California despite the escalating crisis? The literature has described FERC as a classic case of regulatory capture. One camp argues that FERC’s decisions reflect material capture. Research in this vein suggests that sellers of energy such as Enron, Dynergy, and Williams exerted influence over the Commission to stay out of the markets. FERC was aware of the market power problems in California, in other words, but was happy to stand by as power marketers lined their pockets (Beder 2003). The second camp does not go quite as far. It argues that the FERC commissioners did not perceive the problems. Explanations in this vein tend to focus on the period from 1998 to 2001. They point to evidence that power marketers actively tried to repress information and to spread misinformation. Dazzled by these companies’prestige and apparent expertise, the Commission adopted their viewpoint and missed or ignored the available evidence (Duane 2002; Walsh 2004). Even though these explanations identify different root causes for FERC’s inaction, both point to sellers of energy as the relevant culprits. In this paper, I evaluate the evidence for each hypothesis, then probe more deeply into the precise nature of FERC’s misunderstanding. This leads me to identify a different culprit. I begin by showing that there is insufficient evidence to support material capture. The evidence does suggest a case of cognitive capture, however. In contrast to existing explanations, I argue that FERC’s inability to discover market power does not originate with the sellers of energy. The existing explanations assume an information problem. They work with the counterfactual that FERC would have recognized the market power problems had energy marketers not withheld information and spread misinformation between 1998 and 2001. As I show, this counterfactual is not supported by the © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd.44 G. Rilinger Timing of cognitive capture evidence. The commissioners did not miss the relevant evidence. Rather, they did not understand its significance because they subscribed to a flawed understanding of market power that did not account for the idiosyncrasies of electricity markets. This misunderstanding originated with an idea of electricity markets as physical marketplaces and was embedded in the legal doctrine of the “contract path.”This doctrine and its attendant worldview go back to the 1980s, when they were introduced to FERC by utilities. The temporal logic behind the development of a flawed worldview thus points to a different root cause of FERC’s inability to detect market power. Ironically, those who would later become victims of sellers’exercise of market power, were centrally responsible for saddling FERC with the perspective that prevented the agency from recognizing it. 2. Theories of regulatory capture The theory of material capture assumes that the interaction between regulators and regulated can be described as a market. Industry participants compete to purchase regulation that is beneficial to them from an oligarchic set of suppliers, the regulators (Stigler 1971, p. 3). Regulators appear as rational actors who pursue their own material interests by selling regulation to the highest bidder. The first studies looked at cases in which special interests got regulators to erect strong entry barriers around “their”industries. Extensive regulation was thus a sign of capture and “buyers”could easily be identified. Today, however, the dominant form of capture is “corrosive,”that is, aims to weaken regulatory oversight and enforcement (Carpenter 2013a). This makes it harder to identify who benefits and how. Over time, the literature has therefore proposed refinements to the original theory in terms of operationalization, alternative mechanisms, and detail (Dal B o2006, pp. 206–215). In particular, research has identified various tools of capture, such as bribes, lobbying, and regulators’reliance on the regulated for external expertise, information, funds, and personnel (Carpenter & Moss 2013, p. 69). Nonetheless, there is some risk that material capture can be diagnosed whenever someone benefits from a policy. To prevent tautological arguments, Daniel Carpenter has therefore offered a more restrictive definition of material capture: material capture occurs when there is a clear public interest at the time of the alleged capture, an intent to divert the regulators from this interest, the provision of some material advantage, and success in swaying the regulator (Carpenter 2013b, pp. 60–61). That means that the diagnosis of material capture requires demonstration not only of a clear public interest standard that the regulator violated but also of explicit intent to do so on the basis of favors granted. This is a high burden of proof. Explanations that invoke cognitive capture are less demanding. They also fit better in cases in which regulatory oversight corrodes under the influence of special interests. In contrast to material capture explanations, they assume that regulators are trying their best to regulate the environment in line with the public interest. But the regulators develop misperceptions that prevent them from detecting problematic behavior (Weinkle 2020). For this hypothesis, researchers must demonstrate, first, a misperception on the part of the regulator; second, that this misperception originates in interactions with the regulated. Despite much work that explores the impact and social dynamics of regulatory misperceptions (Abolafia2010; Baker 2010; Fligstein & Goldstein 2010,2012), the mechanisms behind cognitive capture are less well-documented. Much of the literature argues that regulators are more likely to listen to those they feel are like them (identification), have a high social or economic status (status), or are in their social networks (social networks) (Kwak 2013, pp. 76–80). However, such explanations tend to remain indeterminate when regulators interact with a variety of different stakeholders of similar socio-economic backgrounds. Because this is usually the case, empirical studies have begun to examine the interactions between regulators and stakeholders more closely. While some research looks at the structure of the networks that mediate interaction between regulators and regulated (Thiemann & Lepoutre 2017), others look at organizational mechanisms (Gray & Silbey 2014), and institutional (Hutchens 2011) or discursive dynamics that establish the substantive meaning of law and compliance (Edelman et al.1999; Weinkle 2020). Although these studies have provided us with a detailed picture of the dynamics and interactional constellations that can lead regulators astray, they have rarely considered the timing of cognitive capture. Mathematical models (Carruthers & Stinchcombe 2010), cultural beliefs (Abolafia2010), or interpretations of specific situations (Swedberg 2010) are similar in that they select some information at the expense of other information. Each can © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd. 45 Timing of cognitive capture G. Rilinger therefore influence the perception of regulators and obscure relevant information. The literature therefore treats such mechanisms as equivalent sources of capture. However, each of these epistemic problems has a different temporal horizon. For example, cultural beliefs emerge in a slower and more diffuse process than the adoption of mathematical models. By conflating different kinds of epistemic problems into one category, disparate mechanisms of cognitive capture are thus flattened into static models of interactional structures. But depending on when an epistemic problem emerges, different players, organizational mechanisms, or network structures may be at fault. We should therefore distinguish between at least two classes of epistemic problems. I will call them “information problems”and “worldview problems,”respectively. Information problems have to do with sending and receiving signals of problematic behavior (Vaughan 1999, p. 277). They are based on a simple counterfactual: if the relevant information was pointed out to the regulators, they would recognize the problematic behavior. Accordingly, we have to assume that the regulators understand a particular type of problematic behavior, but they do not receive or ignore information about its presence. This happens when market participants influence the information that regulators collect and focus on. Special interests can, for example, hire experts to advocate for them on the basis of expertise not matched by the regulatory agency (Zald & Lounsbury 2010). In that case, the expert’s reputation may lead regulators to refrain from an independent analysis and fail to collect conflicting information (Kwak 2013). Capture can also operate through companies’attempts to inundate regulators with complex information. Unable to process it all, the regulators will depend on guidance from market participants (Wagner 2010). Conversely, companies may also block regulators’access to crucial information through secrecy and deception (Gibson 2014; Rilinger 2019). They might, for example, misfile information or withhold it. With information problems, we are thus looking for ongoing attempts to influence what information regulators receive. What I call “worldview problems”affect regulators’basic imagination of the market environment. Worldviews are a set of cultural beliefs about cause and effect, relevant actors, their goals, or important norms. They are intersubjectively shared frames that organize how members of organizations interpret information (Fligstein et al.2017). Incidentally, they also shape how agencies define and articulate their political preferences. These worldviews are embedded in organizational routines, practices, and legal institutions. If regulators’worldview is flawed in important respects, they may spend time looking at and processing pertinent information on problematic behavior but end up drawing the wrong conclusion from it. Such errors correspond to more gradual forms of stakeholder influence. For example, studies have shown how gradual lobbying can shape the legal foundations that determine what regulators view as relevant activities for oversight and create systematic blind spots. Here, the regulatory perspective on the market is slowly settled with a myopic view of the market (Carruthers 2013; Funk & Hirschman 2014). Work on judicial deference provides another set of examples. It shows that industry practices and institutions can slowly influence how judges interpret the meaning of compliance with the law (Edelman et al.1999). Stakeholders might also shape law school curricula, or scientific practices of standard setting and risk assessment, thus leading regulators to adopt standards of evidence that are based on a skewed worldview (Fligstein & Goldstein 2012;Weinkle2020). Because such sources of influence entrench problematic beliefs in the foundation of regulators’approach to the market, they do not just block but disable regulatory dialectic. Interpreting signals of problems as innocuous, regulators have little reason to update their worldview. This leads to path dependencies that entrench errors in the foundation of regulators’approach. In sum, then, the theory of cognitive capture should not just consider the interactive relationship between regulators and regulated, but also decipher the temporal dynamics at play. I have distinguished two broad types of epistemic problems that are likely to evolve over different temporal horizons. Because each may point to a different culprit, capture explanations should begin by determining the nature of the epistemic problem. In a second step, the analysis can then trace the misperception to its origins. To illustrate this approach, I will now turn to the case study. 3. Case: Market power in California’s electricity markets This paper examines problems in the regulatory oversight of California’s electricity markets between 1998 and 2001. At the time, California had just restructured the industry around competitive markets. Before that, it had © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd.46 G. Rilinger Timing of cognitive capture been dominated by three investor-owned utilities. They acted as vertically integrated monopolies that produced, transmitted, and sold energy to end-users. The California Public Utility Commission regulated these companies and determined what rates they could charge to consumers. In 1996, the government decided to end the period of regulated monopolies. The new market system began operation in 1998 (Joskow 2001; Isser 2015). The utilities gave up control over the transmission system to the California Independent System Operator (CAISO) and divested most of their generation assets. To serve end-users, they now had to purchase energy from generation companies in new wholesale markets for electricity. The sellers were energy producers such as Duke and AES, as well as power marketers such as Enron and Williams. Most of the transactions took place in the California Power Exchange, an auction market. In these markets, buyers and sellers traded obligations for the future delivery of electricity at particular locations. In real time, the system operator implemented the resulting obligations as closely as possible, using a battery of ancillary service markets to adjust the financial agreements to real-time fluctuations and purchase reliability services (Sweeney 2002). With the move to competitive markets, certain regulatory responsibilities shifted from the state to the federal level. Traditionally, most transactions occurred within utilities’service territories and the local utility commissions were responsible for regulating them. But because the new wholesale markets transcended state boundaries, transactions now fell under FERC jurisdiction. According to the Federal Power Act of 1935, the agency had to ensure “just and reasonable”rates. In the past, this merely required that they evaluate interstate transmissions, based on the cost structure of utilities. FERC had needed to determine whether utilities managed their systems prudently and proposed rates that represented their costs plus a fair profit. Under competitive markets, the meaning of “just and reasonable”changed. Because markets would now determine the rates that utilities could charge, FERC defined the standard in terms of prices that a perfectly competitive market would generate. Accordingly, it became FERC’s central responsibility to prevent market power: if companies were able to raise prices without loss of business, the markets were not competitive (Wolak 2003). The creation of new market systems thus meant a substantial increase in FERC’s workload because the markets became the primary location for energy purchases. In addition, California was not the only state to restructure. Five New England states, New York, and the Pennsylvania, New Jersey, and Maryland region, enacted restructuring legislation in 1996/1997. By the early 2000s, a dozen states had proceeded with the creation of wholesale markets (Isser 2015, p. 205). With the proliferation of wholesale markets, FERC thus turned from an agency that evaluated occasional interstate transmissions to the main guarantor of competitive wholesale markets. Considering its expanded workload, the agency was relatively small. In 1996, it had only 1,374 employees, with 377 working on electricity (FERC 1998a). 3 For comparison, the SEC had more than twice as many employees at that time. This small size meant that most policy decisions were made at the top of the agency. Four commissioners and one “chairman”composed the leadership. They were political appointees from both parties, but only the chair had their own staff. FERC was an agency that reached most decisions by opening proceedings and inviting comments from all stakeholders. Staff would summarize these filings, conduct independent analyses, and present the resulting documents to the leadership. Below the top, FERC had several different branches of departments that provided input to the proceedings. The most important was the Office of the General Counsel, which vetted any document before it left the agency and provided legal analyses. The Office of Electric Power regulation and the Office of Economic Policy were the other two offices that had to do with electricity markets. While the former was dominated by engineers, the second housed FERC’s economic experts, who would conduct independent analyses, assess policy proposals, and evaluate issues of competitiveness. Throughout the period of interest, these two offices were in the process of merging into the more general “office of market tariffs and rates”(FERC 1998a,p.25).Figure1sketches the resulting structure. In general, the commissioners’staff could draw on expertise from these officestodecidecases. Practically as soon as the California markets opened, energy sellers obtained market power. Initially, its exercise was sporadic and did not affect the system’s reliable operation. But starting in April 2000, a combination of factors vastly expanded the market power in the system, which produced persistent price spikes, drove utilities into bankruptcy, and finally undermined system reliability. Economists estimated that at least 59 percent of all price increases during the summer of 2000 could be attributed to the exercise of market power (Borenstein et al.2002). In most other states, utilities continued to buy the bulk of their supply through long-term “vesting” contracts. This reduced possibilities to exercise market power because trading volumes were lower, and more © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd. 47 Timing of cognitive capture G. Rilinger suppliers chased less demand (Taylor et al.2015). While the other electricity markets thus experienced some degree of market power, California became the first and definitive testing ground for FERC’s market-power methodology. But the agency persistently argued that California’s price spikes were mainly the result of supply shortages. FERC assumed that there simply was not enough generation capacity to serve demand, while sellers of energy actually withheld available supply to drive up prices. The question is: why did the FERC commissioners fail to recognize the presence of market power? Was it material or cognitive capture? And if it was cognitive capture, what was the precise nature of the misperception, and who was responsible for it? 4. Data and method I use archival material and in-depth interviews to reconstruct two periods of regulatory activity. The first ranges from roughly 1989 to 1998. During this time, FERC created the legal foundations to restructure the electricity industry around competitive markets (Hirsh 1999). The second period ranges from about 1998 to 2001. During this period FERC failed to detect market power. In 2001, they changed their assessment and began to fight the exercise of market power explicitly. For both periods, the formal discourse between regulators and stakeholders is preserved in FERC dockets that deal with the creation and regulation of California’s electricity markets. These dockets include formal filings, responses to questions, evidence, and transcripts of technical conferences. In particular, the transcripts are useful because they capture how the regulators talked about central elements of market design, including market monitoring standards. Because FERC had to approve almost all elements of the wholesale markets, these dockets give a comprehensive overview of how these markets were first imagined and then created. I also include an early proceeding during which FERC debated revisions to its market power methodology, cases in which FERC developed its early methodology for contract pricing, and proceedings in which FERC articulated its own vision of restructured energy markets. These dockets capture the reasoning of FERC regulators on market power and energy markets during interactions with stakeholders. After the crisis, FERC became subject to multiple investigations by Congress and the U.S. Government Accounting Office. These investigations produced the available evidence about the informal relations between FERC employees and stakeholders, particularly the Texan power marketer Enron. I include the reports from these investigations, as well as the evidence they collected. In addition, I rely on business documents from the California State Archive in Sacramento in the analysis. These documents chronicle the actions of the Department of Market Monitoring, Operations, the Independent Governance Board, as well as the Independent Market Figure 1 Market and regulatory structure regarding market power issue in California. © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd.48 G. Rilinger Timing of cognitive capture Table 1 Archival material California Independent System Operator (CAISO) Archival material Description Market Surveillance Committee, Reports (1998–2001) California State Archive, R400.007, Box 12, folder 18 –Box 13, folder 14 Material (academic papers, analyses, data charts, etc.) related to market power standard at FERC. ISO Market Surveillance Committee and Board of Governor Meeting Files (1998– 2000) California State Archive, R400.006, Box 6, folder 1 –Box 8, folder 16 All materials used during board meetings, including all material presented to the subcommittees, here: Committee on Market Issues. Contains memos, memoranda and status reports on problems with ancillary markets. Power exchange Electricity Oversight Board, Subject Files California State Archive, R400.005, Box 5, folders 10–25, R400.010, Box 18, folder 1 –Box 19, folder 14 Background material related to market power analysis at PX, 1997–2001. Federal Energy Regulatory Commission Docket Number (accessible via ebrary) Description Contract Path Methodology ER93-706-000 Docket that first develops the contract path methodology in a case against Indiana MI Power Co. Merger Applications and Technical Conferences regarding market power methodology PL98-6 RM98-4 RM98-6 FERC’s early, fruitless attempts to revise their market power standard in the context of mergers (1998). California Parties’Application for establishment of ISO/PX ER96-1663 EC96-19 WEPEX hearings that debate the correct approach to measuring market power in California (1996–1999), as well as all formal filings pertaining to the design and implementation of California markets. Development of orders concerning deregulation and market power analysis (592, 888, 2000) RM96-6 RM95-8 RM99-2 Landmark decisions to open the transmission system in order to prepare the ground for deregulation (Order 888 in 1996) and the subsequent development of Regional Transmission Organizations (Order 2000 in 1999). Contains transcripts that debate market power and methodology in energy markets. Ancillary Market Crisis ER98-2843 Crisis in Ancillary Markets at CAISO, consolidated docket. Contains all filings relevant to crisis and redesign of these markets, including debates about market power in California. Congressional hearings Gov. Body/date Electricity Markets: Lessons Learned from California Committee on Energy and Commerce, House of Representatives, One Hundred and Seventh Congress, First Session, 15 February 2001 FERC: Regulators in Deregulated Electricity Markets Committee on Government Reform, House of Representatives, One Hundred and Seventh Congress, First Session, 2 August 2001 Examining Enron: Electricity Market Manipulation and the Effect on the Western States Committee on Commerce, Science, and Transportation, House of Representatives, One Hundred and Seventh Congress, Second Session, 11 April 2002 (Continues) © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd. 49 Timing of cognitive capture G. Rilinger Surveillance Committee at CAISO and the corresponding institutions at PX. Available material includes memoranda on market operations and monitoring problems, analyses, and minutes of business meetings. These data chronicle California’s attempts to influence FERC’s regulatory approach in the period between 1998 and 2001, efforts to convey worries about market power, and information about relations between FERC employees and electricity sellers. (See Table 1for a summary of the archival sources used.) Because archives collect primary sources for their own purposes, they introduce a selection bias into the data. Besides relying on more than one archive, the best strategy is to triangulate archival data with semi-structured, in-depth interviews. I therefore interviewed 36 officials engaged in market monitoring at the federal and state levels. I talked to members of FERC’s staff and former commissioners who worked on electricity deregulation, and particularly the creation of California electricity markets. I also interviewed personnel at CAISO and PX who were involved in market design, operation, and monitoring during the period. The interviews lasted, on average, between 60 and 90 minutes and were conducted over the phone, or in person when feasible. They were organized around a consistent set of questions but also tailored to respondents’expertise. The selection of participants followed a mix of quota and snowball sampling, based on the different departments involved in the market power controversy. I transcribed the interviews and noted down additional observations upon completion. The analysis followed the guidelines for historical and qualitative case studies (Yin 2017). To minimize the risk of hindsight and rationalization biases, I used the interviews only to confirm and supplement information that I previously established in the archival material. 5. Findings Ifirst show that there is insufficient evidence to sustain a material capture explanation. Concluding that FERC’s inaction resulted from cognitive capture, I then analyze what kind of misperception the commissioners experienced. Here, I first consider and then reject the hypothesis of an information problem. I then show that FERC suffered from a worldview problem and trace it back to legal dogma that originated in the 1980s, when utilities pushed for its adoption. 5.1. Material capture Although some economists have defended the argument that FERC suffered from material capture (Navarro & Shames 2003), the explanation shows up mainly in journalistic, legal, and political analyses (Beder 2003). California governor Gray Davis summarized this view well: “I did not ever feel that [FERC] believed their job was to act in the public interest. […] They operated as if they were a wholly owned subsidiary of the energy companies” (Leopold 2007). 4 The argument is inseparable from the Enron scandal. Enron was a large, highly successful energy company from Texas. For six years running, from 1995 through 2000, Fortune Magazine celebrated Enron as the “most innovative company in corporate America”(McLean & Elkind 2006). Given that Enron was the poster child of the New Economy, the country was shocked when it suddenly declared bankruptcy in December 2001. Amid daily revelations about a culture of greed and corruption, a series of memos surfaced. They pertained to Enron’s activities in California’s energy markets and revealed a variety of “games”that Enron’s traders had Table 1 Continued California Independent System Operator (CAISO) Archival material Description Examining Enron: Developments Regarding Electricity Price Manipulation in California; Energy Market Manipulation Committee on Commerce, Science, and Transportation, House of Representatives, One Hundred and Seventh Congress, Second Session, 15 May 2002 Asleep at the Switch: FERC’s Oversight of Enron Corporation Vol. I–IV Committee on Governmental Affairs, United States Senate, One Hundred and Seventh Congress, Second Session, 12 November 2002 © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd.50 G. Rilinger Timing of cognitive capture time, the utilities lobbied for FERC to adopt this standard because it gave them advantages in negotiations with independent power producers, who needed to use the utilities’transmission grid to sell their output. By obscuring the actual power flows, utilities could draw contract paths that made transport from their own generation assets cheaper and thus discriminated against competitors. FERC accepted the methodology because revoking it would have made things exceedingly complicated and the methodology had already “accommodated substantial amounts of efficient trading in the industry, all at a reasonable administrative cost”(FERC 1993). In other words, contract path pricing was established, convenient, and easy to assess. In the early 1980s, complaints from independent power producers were still a relatively minor issue and the utilities themselves rarely got into disputes over the discrepancies between real and contractual power flows. The utilities handled transmission and often shared the costs of upgrades. Accordingly, “the industry believed that the overall costs and benefits were roughly balanced—others carried your power as much as you carried their power”(FERC 1993). Weighing a relatively frictionless administrative system against an undefined alternative, FERC decided to go with the established model. By the 1990s, when questions about access to the transmission system became exceedingly controversial, the contract path methodology was already deeply embedded in FERC’s dogma. Even regulatory capture, it turns out, is not without its ironic moments. The fundamental error in the commissioners’perception goes back to interactions with those who would later become the primary victims of this influence. 6. Conclusion A variety of modern scandals can be traced to regulatory capture. The Wirecard fraud or the Deepwater Horizon oil spill is recent examples. Despite the explanatory importance of cognitive capture theories, not much attention has been paid to the temporal dynamics behind different epistemic problems regulators may be facing. Drawing on research about the “regulatory dialectic”(Thiemann & Lepoutre 2017), I have therefore argued that the theory of cognitive capture should become triadic. Rather than just focus on the interaction between regulators and regulated, capture analyses should begin by specifying the precise nature of regulators’epistemic problem. While information problems go back to short-term dynamics of secrecy and deception (Gibson 2014), worldview problems are associated with more gradual and long-term influences on regulatory agencies’legal and institutional infrastructure (Wansleben 2021). Depending on the kind of problem affecting regulators, different capture mechanisms may point to different culprits. The empirical analysis has illustrated this argument. While power marketers did their best to influence commissioners’perception in the short run, we have seen that the agency was already predisposed to agree with them. It had adopted a flawed worldview of electricity markets as places. This worldview suggested that the Hub-andSpoke test was adequate and offered an alternative explanation for the evidence of market power, supply shortages. As I have shown, this worldview was embedded in the legal dogma of the contract-path, which dominated decision making in the commission and provided reasons to ignore economic expertise at the agency. It was thus the utilities that caused FERC’s inability to detect market power by convincing it to adopt this doctrine in the 1980s. A capture explanation that carefully analyzes the nature of regulators’misperception thus arrives at a different finding than most of the existing research: it was the later victims of market power who saddled FERC with a perspective on electricity markets that obscured its presence. One implication of this argument is that research on cognitive capture should be more tightly integrated with research on the regulatory dialectic. The latter research carefully explores the interactive dynamics between regulators and regulated. This reveals structural, organizational, and cultural avenues through which influence may be exerted over different periods of time. Future research should therefore explore whether the simple distinction between information and worldview problems should be differentiated further to accommodate these additional pathways. This paper has merely tried to take the first step toward an expanded theory of cognitive capture. Acknowledgments The author would like to thank for their constructive feedback on earlier drafts of this article Andrew Abbott, Jens Beckert, Gary Herrigel, the participants of UChicago’s“Politics, History, and Society”workshop and the participants of the “Sociology of Markets Research Group”at the Max Planck Institute. [Correction added on 29 September 2021, after first online publication: The Acknowledgements section has been amended.]. © 2021 The Author. Regulation & Governance published by John Wiley & Sons Australia, Ltd. 57 Timing of cognitive capture G. Rilinger Data availability statement Research data are not shared. Endnotes 1 I will refer to this family of theories as “cognitive”rather than “cultural”capture. “Culture”typically refers to a set of unstated and implicit understandings of the world, thus excluding more conscious elements of regulatory perception. Cognitive capture refers to influences on regulatory perception more generally. 2 This definition diverges from that of economics, which defines market power as a company’s ability to profitably alter prices away from the competitive level. By adding “significance”as a criterion, FERC created room for interpretation to expand or restrict its enforcement. 3 FERC (1998) Annual Report 1997. U.S. Government Printing Office, Washington, DC, p. 2. 4 Jason Leopold (2007) Cheney Suppressed Evidence in Energy Crisis, Scoop Independent News (24 July). 5 E. Hollings (2002) Time for a Special Counsel. The New York Times, A27 (9 February). 6 U.S. General Accounting Office (2001) Communications Between FERC and Enron. (GAO Publication No. 01-1020R). Washington, DC: U.S. Government Printing Office, p. 3. 7 Committee on Governmental Affairs (2002) Committee Staff Investigation of the Federal Energy Regulatory Commission’s Oversight of Enron Corp (12 November), pp. 41–42. Submitted in: Asleep at the Switch: FERC’s Oversight of Enron Corporation, Vol. 1. 8 FERC (1999) Order Accepting Tariff Revisions and Granting Waiver of Notice, FERC Docket ER99-4462 (12 November), p. 4. 9 Loretta Lynch (2002) Prepared Statement of Loretta Lynch, in: U.S. Congress (11 April 11). Examining Enron: Electricity Market Manipulation and the Effect on the Western States, p. 49. 10 Frank Wolak, Robert Nordhaus, Carl Shapiro (1998) Preliminary Report on the Operation of the Ancillary Services Markets of the California Independent System Operator (ISO). Market Surveillance Committee of the California ISO, Box 6, Folder 6/9, ISO Board of Gov. and Committee Meeting Files, California State Archive, Sacramento, p. 2. 11 FERC (1998) Order Accepting for Filing Proposed Market-Based Rates for Certain Ancillary Services, FERC Docket ER98-2843 (June 30), p. 11. 12 The convention is to multiply the resulting sum by 10,000. Thus, for example, a market with four equal-sized producers would yield an HHI of 4 *0.252 2 *10,000 =2,540. 13 If the applicant controlled more than 20 percent of the market share, which corresponds to an HHI of 2,000, it was considered to have market power. It also measures the ratio of “uncommitted”capacity, where the load obligations of both the applicant and other firms are subtracted from installed capacity. 14 CPUC (1994) Reporter’s Transcript of Hearing. R.94-04-032, Box 69, Vol. 4 (4 August). CPUC Archive, San Francisco, p. 1181. 15 Interview with CAISO Market Monitoring Employee, 13 December 2017. 16 General Accounting Office (2002) Energy Markets –Concerted Actions Needed by FERC to Confront Challenges that Impede Effective Oversight. (GAO Publication No. 02-656). Washington, DC: U.S. Government Printing Office, p. 8. 17 Interview with FERC Economist, 9 February 2018. 18 Interview with FERC Economist #2, 12 January 2018. 19 FERC (1996) Order No. 888. 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