STATE AGENCY DISCRETION AND ENTREPRENEURSHIP IN REGULATED MARKETS: AN ANALYSIS OF A U.S. RENEWABLE ENERGY SECTOR ABSTRACT Barriers to entry in regulated markets are frequently conceptualized as static features that must be removed or overcome if new entrants are to successfully enter a market. However, government institutions regulating markets often consist of multiple levels existing in tension with one another. We suggest that this tension may render regulatory barriers to entry more malleable, even in the absence of policy changes. To test this proposition, we bring the administrative state center stage and examine how regulatory discretion—the flexibility that regulatory agency officers have to interpret and implement public policies created by elected officials—can influence market entry of new ventures, using data on regulatory approval of hydroelectric facilities in the United States from 1978 to 2014. We find that increased state agency discretion improves outcomes for new entrants by reducing the effectiveness of incumbent firms’ political influence and creating opportunities for entrepreneurs to leverage regulators’ institutional logics. This study has implications for the design of public policies that address growing energy demands while balancing environmental goals and the need to reduce carbon dioxide emissions. Keywords: institutional theory, entrepreneurship, nonmarket strategy, regulated markets, regulatory discretion, institutional logics 1 INTRODUCTION The institutional environment can cause entrepreneurial firms to either flourish or fail, by conditioning access to resources (Battilana, Leca, and Boxenbaum, 2009; Tracey, Phillips, and Jarvis, 2011; Battilana and Lee, 2014), facilitating legitimacy and the support of important stakeholders (King and Soule, 2007; Hiatt, Sine, and Tolbert, 2009), and shaping the nature of competitive interactions (Dobbin and Dowd, 1997; Dowell and David, 2011). The impact of government institutions on de novo entrants is particularly high in regulated markets, such as pharmaceuticals, biotechnology, telecommunications, energy, and finance, where regulatory policies can raise costs and influence entry through product standards and approval, pricing guidelines, and licensing rules (García-Canal and Guillén, 2008; Dowell and Killaly, 2009; Hiatt and Park, 2013). Incumbent firms often create additional challenges for new firms by using their political influence to erect regulatory barriers to entry (Dean, Brown, and Stango, 2000). Scholarship has generally treated regulatory barriers as relatively static features of the institutional environment that must be removed or overcome if new firms, because of their lack of resources and political connections, are to successfully enter regulated markets (Sine, Haveman, and Tolbert, 2005). Nevertheless, evidence exists that new entrants enter these markets with significant variation (Sine and Lee, 2009; Gurses and Ozcan, 2015). Little research thus far, however, has theoretically and empirically examined the institutional structures that may allow new entrants to overcome barriers to entry in regulated markets. This inadequacy may be due in part to the common assumption in the organization theory and strategy literatures that government institutions are monolithic with regard to policy change: elected officials enact or repeal policies that fundamentally shape market features and alter firm behavior (Dobbin and Dowd, 2000). Thus, a large body of literature has explored how firms 2 target elected officials through corporate political activities such as lobbying and financial contributions to shape regulatory policies in their favor (Mizruchi, 1989; Walker and Rea, 2014; McDonnell and Werner, 2016). However, this assumption neglects the role of the state in implementing policy (Baron, Dobbin, and Jennings, 1986; Kalev, Shenhav, and De Vries, 2008). Government institutions regulating markets often have multiple levels, including elected bodies that create policies and the state agencies that interpret and implement them (Edelman and Suchman, 1997; Seo and Creed, 2002). Although state agencies are assumed to be constrained by the legislative bodies who monitor them, they can exercise a fair amount of latitude in interpreting and implementing policies (Evans, Rueschemeyer, and Skocpol, 1985; Evans, 1995; Guillén and Capron, 2016). Consequently, state regulatory agencies may implement policies in ways that differ from the original intent of the elected officials who crafted them. Not only can this foster variation in the regulatory environment, even in the absence of policy changes, but it may also affect the barriers to entry for new firms. We suggest that prior work’s conceptualization of government institutions—as a monolithic entity that enacts or repeals regulatory policy—obscures important political institutional factors that could affect market entry and thereby requires a closer theoretical examination. We seek to address this limitation by taking a pluralistic view of government institutions and explore how variation in policy implementation by state agencies affects organizations. Our central argument is that regulatory discretion—that is, the formally granted flexibility that regulatory agency officers have to interpret and implement public policies created by elected officials—can foster new entry in regulated markets by reducing the political influence of incumbent firms and providing opportunities for entrepreneurs to use regulators’ institutional logics to their advantage (Almandoz 2012, 2014; Thornton, Ocasio, and Lounsbury, 2012; Cobb, 3 Wry, and Zhao, 2016; Zhao and Wry, 2016). Drawing upon the public administration literature, we propose that regulatory agencies’ decision making is guided by two competing logics that are enacted depending on the degree of discretion regulators have in implementing policy. When state agency officials have greater discretion to implement policy, we suggest, their decisions are guided more by an institutional logic of public service that emphasizes societal welfare, and less by a legalistic logic that emphasizes adherence to policymakers’ intentions. The logic that guides regulator decision making significantly affects regulatory approval of new ventures. By placing the regulatory agency center stage, we show that regulatory-imposed barriers to entry are not always fixed but may vary depending on how firm and institutional factors interact with regulators’ latitude to implement and interpret the law. Empirically, we examine regulatory approval of new facilities in the U.S. hydroelectric power sector from 1978 to 2014 and consider the impact of institutionalized discretion on state regulatory agency outcomes. This market provides a useful setting to explore the impact of regulatory discretion on new entrants because although the Federal Energy Regulatory Commission (FERC) ultimately grants all licenses to operate, individual state agencies have the authority to place restrictions on federal regulatory approval, resulting in significant variation across states in how regulatory policy is implemented for new facility licensing. This paper offers two primary theoretical contributions. First, it contributes to the institutions and entrepreneurship literature (Hiatt, Sine and Tolbert, 2009; Navis and Glynn, 2010) by examining how state agency decision making can substantively shape the barriers to entry for new ventures and incumbent firms. The predominant view in management literature is that incumbent firms use their political influence to erect regulatory barriers that prevent entry. We seek to uncover the structural aspects of political institutions that can level the playing field 4 for new ventures relative to incumbents in regulated markets even if formal regulations remain static. Second, the paper contributes to the nonmarket strategy literature (McDonnell and King, 2013; Dorobantu, Kaul, and Zelner, 2017; Dorobantu, Henisz and Nartey, 2017) by exploring how firms affect and are affected by the implementation of public policy by regulatory agencies. This is an important area of investigation because regulators are often the primary and most frequent point of contact for businesses (Carpenter, 2002), and, unlike elected officials, regulators are less likely to be influenced by the traditional tools of political influence: they are generally not elected, cannot legally receive financial contributions, and often have job protections associated with civil service policies (Skocpol and Finegold, 1982). Yet, research has only begun to explore the possible mechanisms by which firms influence and are influenced by state agencies through policy implementation. The findings of this study enhance our understanding of these mechanisms by illustrating how variation in policy implementation differentially affects new and established firms. The following section summarizes the literature on entry barriers in regulated markets. We then place the regulatory agency center stage and describe the origins of regulatory discretion, offer a theoretical framework for how discretion can affect incumbent firms and new entrants, and explore moderating factors of the mechanism. We next describe the empirical context—regulatory approval in the U.S. hydroelectric sector—and use quantitative analysis to test our arguments. Finally, we discuss our results and make suggestions for future research. 5 THEORY AND HYPOTHESES Regulated Markets and Barriers to Entry Regulated markets can create substantial obstacles for