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PART II

NONMARKET STRATEGIES AND GOVERNMENT


INSTITUTIONS

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Chapter 5
Political Theory and Government Institutions
This chapter presents concepts and analytical approaches that underpin the formulation of
nonmarket strategies for addressing issues in government institutions. It also provides institutional
background on Congress, legislative behavior, and the executive branch of government. These are
used both in this and in the following parts of the book.
One important set of concepts in Chapter 5 centers on the role and functioning of markets and the
corresponding evaluation of consumers and producers surplus. In economics, these are typically
considered from the perspective of economic efficiency. The development in the book focuses
more on the distributive consequences of markets and the relationship between nonmarket issues
and those consequences. The concept of producers surplus is articulated here in terms of the more
general concept of the rents earned by resourceholders, employees, and others. The distributive
consequences can be thought of as generating a demand for political action. That political action is
an important factor in determining the outcome of nonmarket issues addressed in political
institutions particularly legislative institutions such as Congress and state governments. Political
action also depends on the costs of political action, and those costs are discussed in the chapter and
considered further in the other chapters of this part of the book.
The chapter also introduces a number of theoretical concepts that will be used in several parts of
the book. For example, the prisoners dilemma is a simple representation of a number of
nonmarket situations ranging from collective action to trade politics to bribery. The dilemma is
also the foundation for the free-rider problem, which is common in the nonmarket environment. A
lecture could develop in a formal manner how repetition can resolve some dilemmas.
The chapter introduces Arrows theorem to indicate the impossibility of aggregating in a consistent
manner the preferences individuals might have. This implies that there is no general right answer
to a public policy issue evaluated in terms of preferences and that claimed solutions must make
some restriction on the evaluation of alternatives. One such restriction is that which justifies the
use of consumers plus producers surplus to evaluate alternatives. (This is one form of a utilitarian
standard for ethics analysis as considered in Part V of the book.) Arrows theorem implies that
without restrictions on individuals preferences or restrictions on the alternatives that can be
considered, a political outcome cannot be predicted. Yet our intuition suggests that the outcome
should in some sense be central to the preferences of the voters or legislators. The median voter
theorem is an important result consistent with this intuition and predicts that outcomes under
majority rule reflect the median of the most preferred alternatives of individual legislators.
Centrally located outcomes are also predicted by bargaining theory.
The chapter presents institutional information about the structure and organization of Congress, the
legislative process, and the behavior of legislators. The executive branch is also briefly considered.
A number of executive branch agencies, such as the Environmental Protection Agency and
independent regulatory commissions are considered in Part III.

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To illustrate the use of many of these concepts, the chapter presents a detailed analysis of the
congressional extension of daylight saving time. This example includes an assessment of interests
and their incentives for political action, the role of congressional committees and procedures, and
political behavior. The outcome is interpreted through the median voter theorem. Supporters of a
longer period of daylight saving time continue to work for extensions. For example, Senator
Michael B. Enzi (R-WY) introduced the Halloween Safety Act of 1999 to extend daylight saving
time to the end of the first Sunday of November.
The median voter theorem, and much of the analysis of political behavior in public institutions, is
based on the preferences of institutional actors. As indicated in the chapter, those preferences can
be thought of as derived from the preferences of the members constituents and from his or her
personal policy preferences. These preferences are reflected in the voting of members, and that
voting is evaluated by interest groups. These evaluations are not precise predictors of
congressional voting and are better thought of as indicating preference tendencies.
The film, An Act of Congress, is an excellent introduction to the congressional process, the nature
of political competition, interest group activity, and lobbying. The film is available from Learning
Corporation of America, Simon & Schuster, 420 Academy Drive, Northbrook, IL 60062. The film
follows a bill the 1977 Clean Air Act Amendments with a focus on auto emissions standards.
The issues in 1977 are virtually the same as in the 1990 Clean Air Act amendments addressed in
Chapter 11, and remain current as the 21st century begins. This film is nearly an hour in length, so I
have shown it in a special (optional) session during the lunch hour. Representative Rogers and the
environmental interest groups view the issue as providing benefits to everyone, whereas
Representative Dingell and the auto industry view it as imposing heavy costs on identifiable
groups. One aspect of this film is that it shows that firms and organized labor can be on the same
side of an issue. As characterized in Chapter 6, this is an instance of entrepreneurial politics where
Rogers is the entrepreneur. At the time the film was made, Rogers was moving the bill through
Congress and was in a bargaining mode as he worked to obtain votes. The film does not show
much of the activity of the environmental interest groups, but they were quite active on the issue.
(Rogers at one point refers to environmental experts.) The Sierra Club was quite active on the
issue, but the battle was led by the National Clean Air Coalition. The Coalition flew in constituents
from twelve states whose representatives were largely uncommitted to lobby on the issue.
In preparation for watching the film, students might be asked to pay attention to the relationships
between Congress members and interest groups, the various hurdles that a bill must surmount to be
enacted, how the representatives attempt to frame the issue, and how Rogers and Dingell attempt to
obtain votes. Students might also be asked how important political parties are on this issue and
what role the president had on it. (Neither was very important.)

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Cases
Summertime in the European Union
This case parallels the daylight saving example. It indicates that some nonmarket issues and the
politics associated with them can be present in quite different institutional settings. It also indicates
that the method of analysis developed in the daylight saving time example is quite general but must
be adapted to the institutions governing choice. The institutions of the European Union (EU) are
considered in Chapter 15.
The alternative under consideration is the extension of summertime on the continent of the EU to
the last Sunday in October. Since the United Kingdom and Ireland already have that date, the
decision is one of harmonization among the member states of the EU. Harmonization decisions
require a qualified majority of 54 of the 76 votes in the Council of Ministers and approval by the
European Parliament (EP). (The EU the Council of Ministers was the principal decision-making
body, and its members are the states in the EU.)
Although the institutional setting differs from that in the United States, there are a number of
similarities. First, a variety of interests are affected and politically on both sides of the issue.
Second, the opposition is greatest on the western edges (e.g., western France) of the time zones.
Third, the nature of the interests are similar to those in the United States, but they are organized
differently because of the nature of the EU political system and the corresponding need for the panEU organization of interests. Fourth, there are similarities in the institutional settings. Both have a
vetoone by a parliament and the other by a president. Both have supermajority featuresa
qualified majority in the EU and a filibuster in the Senate and a veto override in the United States.
Also, both use committees to resolve differencesconciliation committees in the EU and
conference committees in the United States.
The EU legislative process begins with the European Commission (bureaucrats who represent the
EU and not their countries) making a proposal for an extension. The Council of Ministers then
adopts by qualified majority a common position, which the EP rejects or approves by simple
majority. If the EP rejects the common position, a conciliation committee can be formed to resolve
differences. It is important to note that under the co-decision procedure the Council is in effect the
legislature and the EP is the veto player, similar to that of the U.S. president.
The analysis of this decision is similar to that for the extension of daylight saving time. The issue
is unidimensionalthe number of weeks of summertimealthough there is the other issue of how
long the decision will remain in effect. In this case, the decision will, as in the past, be effective for
five years, so the issue remains unidimensional. The Council will vote on the extension based on a
countrys preferences, which differ among countries. The EP is organized by political party and is
more responsive to pan-EU preferences than is the Council.
The interests that are likely to be active on this issue include the following:
Pro extension
Recreational interests

Anti extension
GASHE

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Hotel and catering interests


Daylight Extra

COPA
COFACE

In addition, the public in Europe is generally in favor of an extension, although as in the United
States some parents oppose the extension because their children would have to go to school in the
dark of the morning. Also, some residents on the western edges of time zones would oppose an
extension. Transportation and communications companies and probably most large businesses are
in favor of harmonization and are less concerned about the length of summertime. Since the
Commissions proposal provides for harmonization, these industries are likely to support the
extension. The weight of interests is thus in favor of an extension.
The next step is to determine what effect the institutions have on the outcome. To determine this,
the same logic used to analyze the daylight saving time extension will be used. Consider the figure
below, which is analogous to Figure 5-9. Here, m denotes the ideal point of the median voter in the
European Parliament, q is the status quo (the last day of September), and the two pivots for the
Council of Ministers are shown. The Council pivot left is the limit of summertime at which 22
voters prefer a shorter length of summertime. Recall that the voters in the Council of Ministers
are the governments of the member states. The 22 votes to the left of the Council pivot left thus
may be those of the Southern countries that oppose an extension. These 22 votes plus one more
form a blocking minority. To interpret the two pivots, suppose that the status quo were to the left of
the left pivot. Then, a qualified majority of the Council would vote for a (small) extension of
summertime. Similarly, if the status quo were to the right of the right pivot, a qualified majority of
the Council would vote for a (small) contraction of summertime.
Suppose now that the status quo is as in the figure and that all the members of the Council have
utility functions that are symmetric, so each Council member prefers the alternative closer to her
ideal point. Then, a qualified majority would support an extension to the indifference point
indicated in the figure. The distance from the indifference point to the Council pivot left equals the
distance from the Council pivot left to the status quo, so the pivot is indifferent between the status
quo and the extension. Note that no alternative to the right of the indifference point could win
because more than 22 votes would be against it. Note also that the EP would vote for the extension.

22 votes
q
status
quo

22 votes

indifference
point
m
Council
pivot left

median
Council
EP
pivot right
ending date oflength
summertime
of summertime

The agenda setter in this case is the European Commission, and to obtain harmonization it can
propose any extension between q and the indifference point. Thus, with the configuration of
preferences in the figure, the Commission can achieve an extension, and if the indifference point
corresponds to a length that extends at least to the last Sunday of October, harmonization can be
achieved.

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As an exercise, suppose that the median of the European Parliament were to the left of the
indifference point. Then, even though the pivot in the EP prefers a shorter extension than the
indifference point, it prefers the indifferent point to the status quo. The EP then can either approve
the indifference point if proposed by the Commission or it can reject it in which case a conciliation
committee would be formed. This then puts the Council and the EP in a bargaining mode, and the
outcome would be expected to be somewhere between the two points.
If the configuration of preferences is as in the figure, can the EP credibly reject a commission
proposal at the indifference point? No. All players understand that in the Council there is a
blocking minority for any extension to the right of the indifference point. They also know that the
EP prefers the indifference point to the status quo. Consequently, the outcome will be at the
indifference point.
As another extension of the analysis, which status quos cannot be changed? For example, if an
extension to the indifference point is enacted, can that be changed? No. Any proposal to the right
would be rejected by a blocking minority on the left, and similarly any proposal to the left would be
rejected by a blocking minority on the right. The same is true for any length of summertime
between the two Council pivots. This interval corresponds to the gridlock interval in the U.S.
institutional system. As noted above the qualified majority requirement in the EU is quite similar
to the U.S. system when the filibuster pivot is on one side of the median and the veto override pivot
is on the other side of the median.
Teaching the case:
1. Is the issue of the extension of summertime in the EU similar to or different from the issue of
the extension of daylight saving time in the United States?
2. Which interest are in favor of and opposed to an extension in the EU? To what extent is this
similar to that in the United States?
3. Which institutions in the EU serve as the agenda-setter, the legislator, and the veto player?
4. Is the analytical structure of the median voter in Figure 5-9 useful for the analysis of the
extension of summertime?
5. The analysis presented above can be used to work through the interplay between the qualified
majority in the Council, the simple majority requirement in the EP, and the agenda setter.
6. Which status quos cannot be changed in this case?
Outcome:
The seventh EU Directive on summertime established that summertime would end on the last
Sunday in September for 1995 and 1996 and on the last Sunday of October for 1997 and 1998. The
Council was by January 1, 1998 to adopt an eighth directive. The UK and Ireland retained their
ending date of the last Sunday of October in 1995 and 1996.

Repeal of the Luxury Tax

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In the context of Figure 1-1, an action in the nonmarket environmentthe imposition of a luxury
taxhad a substantial impact on the market for the taxed goods. The impact on the market resulted
in losses to producers and consumers, and those losses provided the incentives for interests to seek
repeal of the luxury tax.
This case presents an instance of distributive politics with an emphasis on the demand for and
supply of nonmarket action. One aspect of the distributive issue is obviouspeople buying the
luxury goods pay a tax which reduces their surplus, whereas taxpayers and the public benefit from
the taxes collected. The broader distributive issue, however, centers on the impact of the tax on the
rents of those who produce the luxury goods. The tax shifts downward the demand for the luxury
goods, as illustrated in Figure 5-2. The firms producing the goods lose profits and lose rents on
their fixed factors of production, employees lose jobs or receive lower wages (e.g., through layoffs
or decreased hours worked), suppliers lose sales and hence rents, and communities lose tax
revenues and may experience an increase in the demand for public services. The greater the fixed
factors of production of firms and the lower the alternative wages for employees who lose their jobs
the higher is their demand for repeal.
The surplus of the rich is also reduced, but the rich have other uses for their money, so many of
them will simply not buy the taxed goods. That is, the demand for the taxed goods is probably
elastic, and certainly that is consistent with the observed effect on sales of yachts. If demand is
very elastic, the amount of tax revenue generated is small because of the contraction in the number
of units sold. Indeed, if sales decrease substantially, states lose sales tax revenue, and the federal
government loses income tax revenue.
An elastic demand also means that only the rich who buy the taxed goods lose much. The rich are
widely dispersed, not well-organized, and have high costs of organization. Furthermore, they do not
represent a substantial constituency of members of Congress. The demand for the repeal of the tax
thus comes not from the rich but from the companies and employees that lose business and jobs
because the tax reduces sales. The rich are essentially irrelevant to the politics here.
With respect to specific interest groups, the discussion might focus on the automobile industry. The
U.S. auto producers have relatively few models subject to the luxury tax, so they may benefit from
the tax to the extent that it reduces the demand for foreign luxury autos. The U.S. automakers thus
should oppose repeal of the tax on automobilesas long as the tax does not hit their own models
(or even if it hurts their models less than their gain from the sales gain due to the decrease in the
demand for imported luxury cars). One way to accomplish this would be to index the tax threshold
for inflation, so that the threshold stays above the price of U.S. cars.
To the extent that the demand for the luxury goods is elastic, the loss of rents by the producers is
substantial and results in a high demand for repeal. The producers will be able to generate
substantial pressure on their own representatives, but their coverage is somewhat limited. There are
only a few aircraft producers (in Doles state), but there are more boat manufacturers, although they
tend to be located on the coasts (e.g., in Maine). The fur and jewelry industries probably have
greater coverage. Luxury auto dealers have considerable coverage. The principal advantage these

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interests have is that there will be little interest group opposition. Those opposing the repeal will be
members of Congress concerned about fiscal responsibility.
Another dimension of the luxury tax was the IRS rules implementing it. The IRS was concerned
about evasion, and some of its rules brought howls of protest. (The IRS received 586 complaints
from jewelers alone.) Jewelers complained that the law required that the value of jewelry supplied
by the customer must be counted toward the $10,000. Thus a customer that brought in a piece of
jewelry worth $9,999 to have the stones reset would be subject to a tax on the total value of the
item.
Clearly, the proponents of the repeal of the luxury tax want a low profile and want to keep their
activities out of the eye of the media. Lobbying is the principal strategy. They may also use
testimony. The key messages are that jobs are being lost and that not much tax revenue is being
obtained; i.e., the tax that was intended to hit the rich is actually hitting the worker and small
manufacturers the hardest. They may also want to make campaign contributions to gain access.
The analysis of the effect of the luxury tax should be conducted using industry demand and supply
functions to identify the loss of rents and consumer surplus. The taxes collected and the
deadweight loss can also be identified.
In Chapter 6, a typology of the nature of political competition is introduced. The repeal of the
luxury tax is a clear example of client politics. The benefits from repeal are concentrated among
producers and their employees, whereas the benefits from opposing the repeal are widely
distributed among taxpayers.
If this case is used in conjunction with Chapter 6, the frameworks presented there can be applied.
That is, the demand and supply of nonmarket action for and against repeal can be assessed. The
politics of the repeal of the luxury tax are basically a competition among interest with those
opposed to a repeal (taxpayers) having very little incentive to oppose repeal.
Teaching the case:
The following questions can be used to guide the discussion.
1. Which interests have an incentive to support repeal of the luxury tax? What about the
automobile industry?
2. Which interests oppose repeal?
3. What is the ability of the interests to generate political action?
4. How can the distributive consequences of the tax be identified using demand and supply
analysis?
5. What outcome do you predict?
Outcome:
Even before the luxury tax took effect on January 1, 1991 efforts were under way to repeal it. The
Bush administration opposed repeal, but after a year of mounting pressure it announced it would
agree to an elimination of the tax on boats and aircraft. Congress then voted to repeal the tax on

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boats, aircraft, furs, and jewelry, but President Bush vetoed the bill. Six months later Congress
again passed the same bill, and Bush vetoed it again.
The Clinton administrations 1993 budget reconciliation bill repealed the 10% luxury tax on yachts,
aircraft, jewelry, and furs. The luxury tax was retained on automobiles that cost more than $30,000.
The price threshold increased with inflation in $2,000 increments.
After the luxury tax on yachts was eliminated in President Clintons tax/budget bill of 1993, the
yacht industry began to pick up. Viking Yachts orders picked up, and it expected its workforce to
increase from 65 in 1992 to 600 by January 1994. In 1990, however, it had employed 1,500. One
customer, Ken Fabry, who recently ordered a $2 million yacht said, I dont care how much you
spend for a boat, $190,000 in taxes is ludicrous.1 Maybe its not like the old days, but I think
there is an upward movement, says Alvin Wagner, owner of Jefferson Beach Marina in St. Clair
Shores, Michigan.2
Rhode Island, which has a large boat building industry, repealed its 7% sales tax on boats. Senator
John H. Chafee said, The purpose [of the tax] was to tax the rich and their toys. What it really did
was hurt the toymakers.3
If the luxury tax was so easily repealed soon after it was enacted, why was it enacted in the first
place? The answer is that the provision was added in conference committee largely in secret as a
result of a deal between President Bush and the Democrat majority in Congress. Interests had little
if any opportunity to oppose it at that time.
In 1997 legislation was enacted to phase out the luxury tax on automobiles over a five-year period.

D.S.L. Service Provision


This case is intended more for analysis than for the strategy formulation. The D.S.L. industry
includes many small firms plus the dominant Bell operating company (including Verizon
formerly GTE) that once had a local service monopoly. Some of the small firms provided their
own connections to customers, but most were resellers who leased lines from the Bell company and
resold them to customers. The small companies together have only a small market share, but that
share was probably growing at the time of the case. Local service is generally regulated by a state
public utilities commission (PUC) which imposes common carrier obligations on the dominant
local service company. The focus of the case is on the resellers and the Bell companies, so the
independent providers of connections such as Northpoint and Covad, both of which went bankrupt,
will not be considered. As an analogy, entry into the long-distance telecommunications business
initially began with resellers such as MCI, which eventually along with technological change
allowed competition to flourish.

Business Week, August 30, 1993.


Business Week, August 30, 1993.
3
Business Week, August 30, 1993.
2

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The rents of a Bell company depend on demand, the cost of installing the fiber optics cable, and
variable operating costs. As we have learned from subsequent event, providing the cable can be
costly, and the demand may be considerably smaller than once had been believed. In large part the
price D.S.L. providers can charge is limited by competition from connections provided by cable TV
services. The rents of the resellers depend also on demand but also on the price of leased circuits.
Moreover, connection to the customer has to be made by the Bell company. The marginal cost of
the resellers may be close to constant, but they also have fixed overhead and administrative costs.
The threat to the resellers is that the Bell company can squeeze them by on the one hand raising the
price of circuits and on the other hand affecting at least the initial connection through delays in
installation. Clenching appears to be another tactic for handicapping the resellers. None of these is
probably tightly regulated by the PUC, since these are not part of traditional communications
systems. (SBC argued that the California PUC did not have jurisdiction over D.S.L.) The extent to
which the Bell company can squeeze the small companies is not restricted by markets, since they
could raise the price of a circuit above the $30 level. The limits instead come from the nonmarket
strategies of the small companies, the possibility of PUC action, and the threat of legislation by
Congress or the state legislature.
With regard to the economics of competition, at the time of the case there were many potential
entrants into the D.S.L. market and capital was plentiful. Resellers will enter the market whenever
there is a sufficient margin between the price the market will bear and their costs, the biggest
component of which is the cost of leased circuits. The Bell company thus has the opportunity to
control the rate and extent of entry. Wireless connections are also a large potential factor in this
industry, but wireless has been slow to develop. It is not clear whether wireless systems are lower
cost than fiber optics systems. DirecTV offers satellite connections, but the cost of that service is
high. Competition also depends on service and congestion among alternatives. Cable is hampered
by occasional congestion in the local cable, although the companies have been working to resolve
that problem. The fiber optics systems also can have capacity limitations, although overbuilding
may in the short run have made that potential problem moot.
From a public policy perspective unfair competition is not the issue. The issue is to achieve
competition in the marketplace, and the resellers do that by completing the market and providing
service in niches. If competition between the Bell companies, cable TV, and satellite/wireless
service were sufficiently vigorous, the situation and fate of the resellers would not be important.
The resellers are certainly subject to being squeezed, but the initial investors who funded the
companies knew that and viewed it as one of many factors affecting the riskiness of their
investment. There is probably no violation of antitrust laws here.
The PUCs may have a degree of authority over these companies and the service they provide, and
the nature and extent of that authority can vary from state to state. In California the Bell company
is subject to regulation of telecommunications services, and has some common carrier obligations
to customers, including the resellers. This is a sufficiently new industry that issue are likely to be
contested before the PUC. Regardless of whether the PUC should take action, it will likely receive
petitions for actions from the industry members.

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In California the resellers and other small D.S.L. companies have formed the California Internet
Service Providers Association (CISPA), which has over 100 members. The only large company in
the CISPA may be Earthlink. The CISPA takes nonmarket action in a variety of institutional arenas
ranging from legislatures to courts to regulatory agencies. CISPA has opposed the Tauzin-Dingell
bill, which they claim will force hundreds of ISPs out of business. In California CISPA has filed
petitions with the California PUC seeking to restrict Pacific Bells ability to squeeze them. In 2001
it filed a petition arguing that Pacific Bell/SBC was slow in providing connections, practiced
clenching, and used contract terms giving it an unfair advantage. CISPA claimed that Pacific
Bell/SBC had leveraged its telephone monopoly into a DSL monopoly. In particular, SBC-ASI sent
the ISPs a new DSL transport contract, which require[s] the ISP to pay SBC-ASI directly, whether
or not the end-user pays for the service or disputes the charges4 This appears to shift some risk
from SBS-ASI to the ISPs. The CISPA sought a temporary restraining order to stop the contracts
from taking effect.
Earlier in the year SBC-ASI announced new services that forced the ISPs either to migrate
customers to a new protocol. Customers who remain on the old service would have lower speeds
and burst rates. The complaint filed with the PUC pertained to tactics that include shutting
down the consumers DSL connection and requiring the consumer to order an entirely new DSL
linea process that typically takes three to four weekseven though the requested change could
be accomplished in a short period of time and with minimal service disruption to the end user.5
This is clenching. CISPA also complained that in the case of an existing ISP customer wishing to
obtain a DSL connection a typical tactic is for an SBC-ASI representative to tell the consumer that
the SBC-ASI representative can set up DSL service for the consumer with the consumers current
ISP, when in reality the technician is placing an order for SBCs own affiliate, Pacific Bell
Internet.6 The CISPA and Pacific Bell/SBC attempted to negotiate a resolution of the issue, but the
negotiations failed and were terminated.
Part of the nonmarket strength of the ISPs is that they claim to provide service to small businesses
and consumers that might not otherwise be served, or might not be served as quickly by Pacific
Bell. Another potential source of nonmarket leverage of CISPA is that SBC seeks authority to
provide long-distance service throughout the state, and a condition for granting that authority is that
there is sufficient competition among service providers. If the independent ISPs are driven out of
business, then competition may be inadequate, which is the argument made by CISPA. The
objective of the ISPs is to obtain more favorable contract terms and competitive position.

CISPA, Motion, filed with the California PUC, July 25, 2001, p. 5.
CISPA, Verified Complaint , filed with the California PUC, July 25, 2001, pp. 2-3.
6
CISPA, Verified Complaint , filed with the California PUC, July 25, 2001, p. 3.
5

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Chapter 6
Political Analysis for Business
This chapter develops a parsimonious approach to the analysis of political behavior. The approach
combines the institutional knowledge from Chapter 5 with an analysis of interest groups and
provides the foundations for the formulation and implementation of political strategies as
considered in Chapters 7 and 8, respectively. Political action can take the form of private collective
action as considered in Chapter 4 or can be directed to political institutions. This chapter and the
other chapters of Part II focus on legislative institutions and in particular Congress. Institutional
information on regulatory and executive branch agencies is provided in Part III. Institutional
information on Japan is presented in Chapter 14, the European Union and Germany in Chapter 15,
and China in Chapter 16.
The underlying theory is that of distributive politics in which political action is motivated by the
benefits it can yield. The moral motivations of collective action are also briefly considered and are
developed in more detail in Part V. Distributive consequences and moral motivations are one side
the demand side of the political action calculus. The supply side focuses on the cost of
individual and collective action. The notion of the supply and demand of political action is more
than a metaphor and, in principle, can be used to predict the amount of action generated. In
practice, the approach is used to provide an assessment of the amount of the political action likely
to be generated on an issue. This assessment can be summarized in the distributive politics
spreadsheet presented in Figure 6-4.
The perspective taken in the chapter is that most nonmarket issues addressed in political institutions
are contested and that the competition over those issues, along with characteristics of the
institutions and the preferences of institutional officeholders, are the principal determinants of the
outcome. This competition is illustrated in Figure 6-3 in the context of the distributive politics
framework. The nature of that competition is characterized in a highly simplified manner in Figure
6-2. This characterization is used in a number of the subsequent chapters and in several cases.
The underlying framework is based on the concept of structured pluralism, which is a general
perspective for assessing the political economy of nations. This perspective is applied in Chapter
14 to the political economy of Japan. The perspective is that private interests are the principal force
affecting political outcomes on nonmarket issues. Public policy analysis, in contrast, provides
technical information about alternatives, whereas interests provide politically-relevant information.
This perspective also recognizes the pluralistic nature of interests, so interests may compete on
issues. This is particularly the case on issues characterized by distributive politics.
The building blocks of the framework are an interests demand for political action on an issue and
the cost of taking that action. The demand depends on the aggregate and per capita consequences
likely to result from an alternative and any substitutes that allow the interest to offset some of those
costs. The concept of substitutes is developed in the chapter and is applied in the Tobacco Politics
case. The costs of political action include the direct costs of taking action and other costs such as
the cost of organizing for political action. The assessment of the costs of political action includes

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the assessment of the likely effectiveness of that action, which depends on the numbers
participating in the political action and their coverage of legislative districts. The results of the
assessment of the demand and cost of political action by the affected interests can be summarized
in a distributive politics spreadsheet.
Two points worth emphasizing about the distributive politics spreadsheet are that it pertains to a
specific political alternative and that it pertains to interest groups and not institutions. The
spreadsheet and the analysis that underlies it are specific to the particular political alternative in
question. In the Boeing example the alternative is seeking an exemption for job-creating exports.
The alternative considered determines which interest groups are on which side of the issue. In the
Boeing example, that alternative puts the tax-exempts on the other side of the issue from Boeing.
The second point is that the spreadsheet pertains to the action of interests and interest groups and
not of institutional officeholders. The institutional officeholders are typically the target of the
political action as in the case in which the political action takes the form of lobbying. The
institutional officeholders also take action, but mostly it is within the structure and procedures of
the institution. The principal exception is political entrepreneurship in which a legislator seeks to
initiate action to appeal to or represent some organized or unorganized set of interests. Institutional
officeholders are important to the outcome of many nonmarket issues, but most legislators are
interested in the consequences of alternatives for their constituents. The interests of those
constituents are what is summarized in the distributive politics spreadsheet.
The Boeing and Foreign Leasing example provides a comprehensive example of political analysis
and strategy formulation. This example is sufficiently complex that a lecture could focus on the
example reviewing how the approach is applied. This example is also useful in making the point
that even an important, well-managed, and economically-powerful company like Boeing may not
be able to muster enough political influence to obtain a favorable outcome. In this example,
interests and institutional officeholders weigh against Boeings interests.
A template for the distributive politics spreadsheet is included in the transparencies.
An Example of Political Analysis
The following is an example of political and institutional analysis. This example can be used as a
basis for a lecture to illustrate the incentives that distributive consequences provide for political
action and the difficulty of sustaining collective action. The example also illustrates the difficulty
Congress often has in resolving distributive issues.
AARP and Catastrophic Health Insurance
In the mid-1980s, the American Association of Retired Persons (AARP) initiated a broadscale
campaign to obtain long-term care for the elderly. In 1987, the Reagan administration, under the
leadership of Health and Human Services Secretary Otis Bowen, introduced legislation to provide
limited coverage for the elderly against catastrophic illness. Because of the presidents
commitment not to raise taxes, the coverage was to be financed by a small increase in the monthly
premiums paid by those who elected Medicares Part B physician and outpatient cost coverage
program.

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AARP is representative of a number of interest groups, except for its size. To attract its 32 million
members, it offers a variety of services. In 1988, AARP generated revenues of $262 million, of
which membership dues accounted for $90 million. AARP received $34 million from its
publications, $30 million from the sale of prescription drugs, interest income of $31 million, and
$74 million from other activities.
In conjunction with the Villers Foundation, AARP organized a coalition, Long Term Care 88, to
support catastrophic care legislation. The coalition also worked to influence the positions of
candidates in the 1988 presidential elections. At the same time, Democrats in the Congress saw the
Reagan administrations initiative as an opportunity to expand Medicare, which had incurred
budget cuts during the previous six years.
Surveys of AARP membership had consistently indicated that a long-term care program was their
highest priority, and AARP sought to expand the Reagan administration initiative. The problem for
AARP was that the federal deficit and the presidents commitment not to raise taxes meant that the
expanded program, estimated to cost more than $20 billion annually and eventually perhaps as
much as $50 billion, could not be funded within the realities of the federal budget.7
Increasing the monthly premiums to cover the cost of the catastrophic care program was judged to
be infeasible because the premiums would be so high that many Medicare participants would drop
Part B coverage. The congressional supporters of the expansion decided to finance the catastrophic
care program by taxing those who would be able to pay, while exempting from the tax those who
were likely to drop Part B coverage. Their strategy was to impose a surtax, referred to as a
supplemental premium, on the 33 million beneficiaries of the program.8 Under this strategy, the
97 percent of the beneficiaries who elect Part B coverage would have $4 per month withheld from
their social security checks. The 40 percent of the beneficiaries who pay $150 or more in federal
income tax would in addition pay the surtax, which would rise with income to a maximum of $800
per person or $1,600 per couple. The surtax was to increase by more than 30 percent by 1993. To
meet Gramm-Rudman-Hollings budget restrictions, the Ways and Means Committee specified that
the additional premiums and surtax be front-loaded with the benefits to be phased-in after the tax
had begun to be collected.
AARP was successful in pressuring Congress to enact the catastrophic insurance program. Once
enacted, however, a grassroots uprising against the surtax began among the elderly. Although the
catastrophic insurance program was undoubtedly supported by a majority of the elderly, it was
impossible for AARP to commit all its members to support the program. AARP members picketed
the Florida AARP headquarters protesting their leaders support for the program. During the
August congressional recess, many members of Congress were sharply criticized, and even
harassed, upon return to their districts. In a highly publicized event, constituents blocked the
automobile of Representative Dan Rostenkowski (D-IL), chairman of the Ways and Means

The catastrophic illness program was actively opposed by the Pharmaceutical Manufacturers Association which
feared that the program could result in price controls for drugs and in provisions mandating the substitution of generic
for brand name drugs.
8
Medicare is financed by payroll taxes, general tax revenues, and premiums paid by beneficiaries.
7

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Committee, calling him Rottenkowski. Such strong protests soon led Congress to take the rare
action of repealing a law it had enacted only a year earlier.9
The supporters of the expansion of the Reagan administration proposal had attempted to
redistribute income from one group of elderly to another. This generated protests from those
elderly who would have to pay for the program. The most vociferous protests were from those who
would pay the surtax but would not receive benefits. Nearly 3.3 million of the elderly had longterm care insurance policies paid by their former employers. Furthermore, many of the elderly had
purchased medigap insurance from private insurers and did not need the coverage provided by
the program. A 1989 Congressional Budget Office (CBO) study estimated that 7 million elderly
already had coverage in part or in full from their previous employers and thus would receive little
or no benefit from the program. Some 6.9 million elderly had no coverage beyond Medicare and
would benefit from it as would 11.7 million with private insurance who would have their premiums
on the private insurance reduced because double coverage was prohibited by the law.
After the repeal, as Representative Willis Gradison (R-OH), a co-author of the 1988 bill, stated,
Even if you get 65% of the membership behind you, what weve learned is that the remaining 35%
may have an effective political veto.10 Gradison also remarked, referring to AARP, All of us are
entitled to be skeptical when any group purporting to represent the elderly says, Our members are
willing to pay for this if you give us that.11
One of the most active supporters of repeal of the catastrophic insurance program was the National
Committee to Preserve Social Security and Medicare, which used scare tactics to induce the elderly
to pressure the Congress.12 It referred to the financing of the program as a seniors-only surtax
and implied that everyone participating in Part B of Medicare would have to pay the full $800.
New grassroots organizations were also formed to oppose the financing of the program. United
Seniors of America was formed and conducted a campaign to help spread the word to get this
unfair law changed. The Conservative Caucus conducted a campaign against the Catastrophic
Coverage Tax urging seniors to contribute to the campaign because their contributions could help
save millions of Americans (including you) from paying an extra $800 per year (and more) in taxes
year after year after year.13 The result was over 5 million letters to Congress members on the
catastrophic illness program. The attack on the financing of the program had spread to the program
itself, and for many members of Congress repeal was the easiest way out of the predicament.
The repeal occurred after repeated attempts in both the House and the Senate to preserve the
program in some modified form. Rostenkowski introduced a proposal to reduce the surtax to no
more 5 percent of an individuals tax liability, but the surtax could still go as high as $800. In
addition, the Rostenkowski proposal would double the deductible for Part B coverage and increase
premiums by over 10 percent in the first year and by over 20 percent by the fourth year. The bill
The repeal did not cover certain benefits provided under Medicaid, the program jointly-funded by states and the
federal government.
10
The New York Times, December 27, 1989.
11
Congressional Quarterly Weekly Report, October 14, 1989.
12
The National Committee has a membership of 5 million, a budget of $48 million, and was headed by James
Roosevelt, son of Franklin Delano Roosevelt.
13
Congressional Quarterly Weekly Report, October 14, 1989.
9

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did not garner substantial support. Senator John McCain (R-AZ) introduced a compromise that
would repeal both the surtax and two costly benefits, stop-loss coverage of doctor bills and
coverage of prescription drug costs, but would preserve unlimited hospital stay coverage plus some
other benefits. Senator McCain successfully steered the bill through the Senate, but the House
voted 360 to 66 for repeal, and the Senate went along.14 The program had been repealed before it
had even taken effect.
The inability of AARP leadership both to discern the preferences of its members and to control their
independent political activity was the cause of a major embarrassment to those who had supported
the catastrophic insurance program. It also was a signal that AARP was not as powerful as had
been believed.15

Cases
Tobacco Politics
Transparencies are available for this case tobaccopolitics.ppt.
This case provides an opportunity to apply the framework assessing the motivations for political
action, the demand for and supply of political action, and the nature of the politics.
First, consider the politics of the Tobacco Resolution. The resolution was the result of three-sided
bargaining among state attorneys general, tobacco companies, and class action (trial) lawyers. The
trial lawyers were parties to the bargaining because they represented class-action plaintiffs who
claimed injury due to cigarette smoking. The politics of the bargaining were largely entrepreneurial
with the trial lawyers and the state attorneys general representing interests, plaintiffs and taxpayers,
respectively, acting as entrepreneurs with the tobacco companies bearing the cost of the resolution.
(The resolution was also beneficial to the tobacco companies relative to going through a series of
trials and subsequent appeals.) The motivations of the bargainers basically resulted from
distributive considerations, although one could argue that there were some moral motivations
associated with reducing smoking. The state attorneys general, for example, sought funds to cover
healthcare costs borne by taxpayers through the state budget. They were also interested in claiming
credit for the resolution and for some positioning themselves for runs for higher offices.

The program had initially been approved by a 328 to 72 vote in the House and an 86 to 11 vote in the Senate.
One explanation for the willingness of a number of the members of Congress to repeal the program was that a
catastrophic illness program for the elderly, many of whom already have insurance coverage, was not as important as
providing care for those who had no health care insurance. After its defeat, AARP apparently concluded that a better
strategy was to work for health care coverage for all. Some members of the Congress also voted for repeal because
they believed that with the slate clean they could develop a new plan. Representative Gradison, however, commented,
I think the slate is going to remain clean for some time to come. Congressional Quarterly Weekly Report, October 7,
1989, p. 2635. AARP was an active supporter of the Clinton administrations attempt to restructure the U.S. health care
system and provide universal coverage. As a result of its political activity, Senate Republicans held hearings on whether
AARPs tax-free status should be withdrawn
14
15

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Next, consider S.1415, which would turn the Tobacco Resolution into law. The bill would increase
regulation of tobacco including giving the FDA authority to regulate tobacco as a drug. The bill
would also impose a hefty excise tax to pay for health care costs and would put tobacco company
documents in the public domain. Liability of tobacco companies would be capped at $6.5 billion a
year. Advertising and promotion would be restricted, although cigarette-only stores would be
exempt from the restrictions on promotions. Retail stores would be required to obtain a license to
sell tobacco, and as mentioned above farmers would receive transition payments.
The bill S.1415 represents the negotiated resolution and hence can be viewed as the status quo. A
variety of interests that were not party to the bargaining over the resolution would be affected.
Some of those, such as tobacco farmers, were provided for in the bill, but most were not. The
distributive consequences of the bill fall on identifiable interests most of which are already
organized for nonmarket action. Their objective is to reduce the costs they would bear if the bill
were enacted. Those interests thus were positioning themselves as clients to be served by
Congress, and they sought exemptions, transition payments, and other special provisions to reduce
their burden. Those who agreed to the resolution were political entrepreneurs who represented
dispersed taxpayer and smoker interests. Any congressional responses to the clients would reduce
the benefits to the dispersed taxpayer and plaintiff interests. Consequently, S.1415 was considered
in the context of client politics. The clients were likely to use behind the scenes strategies such as
lobbying rather than more public strategies such as grassroots demonstrations.
On the side of dispersed interests are two interest groups: trial lawyers who seek to preserve their
fee arrangement and the tobacco companies (representing tobacco farmers, for example). Whether
these interests would be better or worse off if the bill failed and new negotiations resulted is not
clear. Since they agreed to the resolution they may be better off with the resolution than with
renewed bargaining or going to trial. The interests of the tobacco companies and the trial lawyers
are diametrically opposed on some dimensions of the resolution, such as the cap on liability. Both
the tobacco companies and the trial lawyers have a high demand for nonmarket action, are wellorganized, and have considerable resources. Their numbers and coverage are limited, however.
There are not many trial lawyers involved in the class action cases, but they may be able to call
upon support from the Trial Lawyers Association, which is one of the more active and effective
interest groups at the federal level. The Trial Lawyers Association is closely linked with the
Democratic Party and is often the largest contributor of campaign contributions to Democrats. The
tobacco companies can to some extent call on their rent chains (suppliers, distributors, farmers, etc.
see Chapter 7) for support, numbers, and greater coverage. Both interest groups will continue to
be active in tobacco politics.
State attorneys general also have an interest in the passage of S.1415, and their influence is through
their links to members of Congress. They, however, are few in numbers and those they represent
have dispersed interests and high costs of organizing for and taking nonmarket action. Hence, they
are not likely to be involved, and the state attorneys general are unlikely to be able to generate any
substantial effective nonmarket action.
The principal clients in this case are the interests that were not represented in the bargaining over
the Tobacco Resolution. Any exemptions and special provisions for them would likely be at the

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expense of the dispersed interests rather than the trial lawyers and the tobacco companies, which is
characteristic of client politics.
Antismoking groups have few effective substitutes for S.1415, and their moral motivation makes
their demand high. They are already well-organized and have chapters that give them extensive
coverage, although the number of active participants in their activities is limited. They thus have a
moderately high demand for nonmarket action, low costs of organizing for nonmarket action,
modest resources, and small numbers. They will support stronger restrictions on smoking and large
transfers to taxpayers and plaintiffs. Their effectiveness, however, will be limited by the relatively
small number of active participants and limited resources. (Note that these groups have been
working on restrictions on smoking for decades with only limited success. It was the class action
lawsuits that led to the tobacco resolution.)
Wholesalers, convenience stores, grocery chains, and other retailers have high aggregate and per
capita demand for exemptions and for less stringent restrictions. They have few substitutes for the
decrease in demand that the excise tax and the restrictions on advertising and promotion would
cause. Their demands are not identical but their interests are aligned. In addition to decreased
cigarette volume, wholesalers will incur higher insurance and theft costs, and grocery stores will
lose some slotting fees. All three of these interests have large numbers, substantial resources,
extensive coverage, and low costs of organizing for nonmarket action. They will be active and
effective in the client politics.
Cigarette-only stores are relatively few in number compared to convenience stores, however, and
the adult bookstore part of the business of many of them will limit their effectiveness. Their
demand for nonmarket action has already been met to some extent by exempting them from
restrictions on point-of-purchase promotions. They will work to preserve that exemption and
otherwise are likely not to be active. (Presumably, anyone who enters a cigarette-only store is there
to buy tobacco products, so promotions represent interbrand competition and are likely not to affect
aggregate demand for tobacco products.)
Advertising agencies receive a significant portion of the estimated $5 billion in advertising and
promotional expenditures on cigarettes, and S.1415 could significantly reduce that spending. The
agencies have no substitutes for this source of revenue, and hence those with tobacco clients (high
per capita benefits) have a substantial demand for nonmarket action. Their number is limited,
however, and their coverage is likely to be moderate. Their cost of organizing for nonmarket action
is probably moderate. They will be able to supply only limited nonmarket action unless they are
able to enlist the AAAA. If they can do so, they gain numbers, coverage, and resources.
Concert promoters and organizers of golf and tennis tournaments would lose sponsors because of
restrictions on promotional activities, but they have close substitutes in the form of other
advertisers interested in sponsoring events. The demand for nonmarket action thus is small.
Moreover, they are few in number and have very limited coverage. They are not likely to be very
active or effective.
Tobacco farmers are provided for in S.1415, although farmers have a demand for greater support.
They have as substitutes other crops that they could grow, although tobacco can be grown on

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marginal land, so substitutes may not be very close. There are many tobacco farmers in a moderate
number of states, and farmers are well-organized for nonmarket action. They have modest
resources. They can be expected to be active in seeking higher transition payments. If they can
enlist the support of larger farmer organizations, such as the Farm Bureau, they would be able to
generate substantial and effective nonmarket action.
Universities are unlikely to be active. They have the alternative of selling tobacco stocks as a
substitute for their moral concerns.
The overall prediction from this analysis, which can be summarized in a distributive politics
spreadsheet, is that there will be substantial nonmarket action on S.1415 with the clients seeking to
whittle down the bill to their benefit or to load the bill with special provisions and exemptions. The
bill stands a good chance of stalling in Congress.
Teaching the case:
The organization of the discussion can center on filling in a distributive politics spreadsheet. The
discussion can be led with the following questions:
1. Which interests are affected by S.1415? Which of them participated in the bargaining over the
Tobacco Resolution?
2. What is the nature of the politics of S.1415?
3. Assess the amount of effective nonmarket action each interest is likely to mount.
4. What strategies will the interests choose?
5. What is the likely outcome of S.1415 and why?
Outcome:
S.1415 was referred to the Commerce Committee, which made changes in the liability provisions.
This caused the tobacco companies to withdraw their support for the bill, and they launched a $40
million advertising campaign against the bill. Interest groups then became more active, and the
lobbying by those favoring and opposing the bill intensified. Some Republican senators led a
filibuster against the bill and three cloture votes failed on party-line voting. On a fourth cloture
vote, thirteen senators switched their votes, but that was not sufficient to invoke cloture. The bill
died. The politics of S.1415 were sufficiently complex and intense that the resolution had
unraveled. A new agreement was negotiated in 1999.
An analysis of S.1415 is provided in Alan Wiseman, Votes for Smokes: Vote-Buyer Theories and
Tobacco Politics, Working paper, Stanford University, 1999.

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Scrubbers and Environmental Politics


Transparencies are available for this case scrubbers.ppt.
The issue of scrubbers and environmental policy is a recurring one and in Chapter 11 is considered
in the context of the 1990 Clean Air Act. The issue addressed in this case is whether to require
scrubbers for new power plants; i.e., the NSPS pertains to new power plants and not to old ones.
The issue in 1990 was whether to mandate scrubbers for old (existing) power plants, and the
motivation was the reduction of acid rain. In 1977, the politics of the issue overwhelmed
considerations of economic efficiency, and the most efficient means of controlling emissions were
not mandated. In 1990, efficiency considerations ultimately prevailed, as concerns mounted about
the high cost of scrubbers and the effect on the price of electricity and the possible loss of jobs.
The economics of the scrubbers issue are considered in Chapter 5.
The objective of this case is to assess the distributive consequences of a legislative alternative and
the possibility of coalition formation to achieve an outcome preferred by groups with quite different
interests. One point made by the case is that efficiencyor good public policy in this casedoes
not dictate the outcome of a political competition.
In the context of the nonmarket issue life cycle, this issue is in the administrative stage of the Clean
Air Act Amendments. The scrubber issue itself is at the interest group stage.
Teaching the case:
One way to begin the discussion of this case is to ask what is the most efficient means of achieving
the NSPS. (Whether the NSPS represents the right amount of pollution to allow is quite another
issue.) The answer is that utilities should be allowed to meet the standard in the manner they deem
best. That is, to achieve the environmental objectives at the lowest cost, which ultimately means
the lowest cost to customers. That is, the utilities would choose the most efficient means of
meeting the NSPS whether that is using low sulfur western coal or scrubbers. (There are a number
of other alternatives such as coal washing that removes sulfur prior to burning.) For many utilities
low sulfur coal is the more efficient alternative. (This is considered in Chapter 11.) The next most
efficient alternative is to mandate scrubbers in the east but not in the west, since in the west the
power plants will use low sulfur coal anyway.
The next question might be What is Congress likely to do? The worst alternative is to require
scrubbers everywhere, which is what the Congress did. The students should not be told this but
should arrive at this conclusion.
The next question might be to ask about the politics of the situation. This is a case of distributive
politicsnote that environmentalists concerns are based on their preferences and hence are
distributive although they may also have some degree of altruism. Environmental interest groups
claim to represent people more generally whose interests would not otherwise be represented, and
in that sense, they act as political entrepreneurs. That claim may not be very persuasive in this case
because the benefit would only occur in the west and would involve a reduction substantially below
the NSPS. A more credible claim of representing the unrepresented can be made by the power

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companies in the east which will be forced to install scrubbers at a substantial cost to consumers.
Much of those costs could be avoided by purchasing western coal. Doing so could also improve air
quality relative to the unreliable scrubbers.
The interests affected by the political alternative of mandating scrubbers are 1) eastern coal
interests both mining companies and the UMW, 2) western coal interests primarily new
mines that would open and new employees who would be hired, 3) electricity customers in both the
east and the west, and 4) breathers primarily in the west who would have somewhat better air
quality if scrubbers are mandated. In terms of the Wilson-Lowi matrix, this issue involves interest
group politics.
Note that the western coal interests are largely future interests, since new mines would be opened
(or existing mines expanded) in response to an increase in demand by new eastern power plants.
These mines have as yet no sunk costs so their future rents equal their future profits. Future
interests are costly to organize and hence cannot be expected to be very active in the political
competition. In contrast, eastern coal interests are already in place. Eastern mines have high sunk
costs and thus rents that are considerably in excess of their profits. UAW miners also earn
substantial rents as a result of their high wages and generous benefits. There are thus substantial
rents being earned in the east on mining jobs and on mining assets and hence a high demand for
taking political action.
The eastern coal interests are already well-organized, so they have low costs of supplying political
action. Thus, eastern coal interests can be expected to generate considerable political pressure, and
western coal interests can be expected not to generate much political pressure. Even though eastern
coal interests are likely to be much stronger than western coal interests, those interests do not have
coverage of enough political districts to pass a measure mandating scrubbers.
Environmental interest groups are also well-organized and have a substantial demand for political
action in support of mandating scrubbers. Environmentalists have little concern about whether
eastern or western coal is burned in eastern power plants. Furthermore, they seem to have little
concern for the dirtier air that could result from scrubbers that do not work effectively. That is,
scrubbers and eastern coal can result in higher emissions than western coal and no scrubbing.
Environmentalists are primarily interested in preventing the degradation of air quality in the west,
but they are unlikely to have enough strength to pass a measure mandating scrubbers only in the
west.
This analysis identifies an opportunity for a coalition of eastern coal interests and environmentalists
to support mandating scrubbers nationwide. This coalition was never official but was implicit as
both groups backed the mandating of scrubbers.
The opposition to this coalition was primarily the power companies. Because of average cost
pricing imposed by regulation, the costs of scrubbers are passed on to customers. Consumers have
high costs of organization and for many the per capita additional cost of electricity is not high, so
they cannot be expected to be politically active. Business customers might oppose mandatory
scrubbers, but at this point in time the costs of scrubbers were not well-known. The higher price of
electricity would result in the loss of jobs, but those potentially affected would be hard to identify

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and even harder to organize. One body that could represent customers would be the state
regulatory commissions which are responsible for passing on the cost of scrubbers to consumers.
They were either not active or ineffective on this issue, however, because of the associated
environmental politics.
The distributive politics spreadsheet is useful for this case and helps explain the coalition between
eastern coal interests and the western environmentalists. A spreadsheet is provided in the
transparencies.
Outcome:
Congress mandated scrubbers for new coal-fired power plants. The politics and economics of this
issue are analyzed in Dirty Air/Clean Coal, by Bruce A. Ackerman and William T. Hassler, Yale
University Press, New Haven, CT, 1981. They conclude that the scrubber coalition produced higher
electricity costs, dirtier air in the east, and somewhat cleaner air in the west. Scrubber technology
and maintenance improved substantially over time, and they are now quite effective but remain
quite costly. (See Chapter 11.)
In congressional language, a scrubber is now referred to as a Phase I technology defined as a
technological system of continuous emissions reduction that achieves a 90 percent reduction in
emissions of a pollutant.16
The sludge created by a scrubber is still a problem, although a limited market has for sludge has
developed. The Tennessee Valley Authority (TVA) invested in more expensive scrubber systems
that produces a powder rather than gooey sludge. The TVA sells the powder to companies that turn
it into gypsum used in the production of wallboard.

The Section 936 Tax Credit


This case centers on an important issue addressed in the legislative arena and on the nonmarket
strategies of corporations seeking to preserve the tax credit. The issue is well-identified, interest
groups are already in place, and it is beginning to move through the legislative process. The issue
has arisen because of the Clinton administrations desire to reduce the federal budget deficit and
restructure a tax benefit that was intended to create jobs but which is a very costly means of doing
so. Most policy analysts would probably agree with both of these points. Another dimension of
this issue is a concern on the part of some members of Congress, such as Senator Pryor, about the
high profits in the pharmaceutical industry. This dimension will motivate some members, but those
are probably not the pivotal ones.
An important issue is whether mainland corporations would leave Puerto Rico if the tax credit were
eliminated. This is difficult to answer because corporations do not wish to state publicly their
intentions; e.g., stating that they would leave if the credit were eliminated might appear to be a mild
16

Congressional Quarterly Weekly Report, November 24, 1990, p. 3947.

127

form of extortion. In reality, a number of the capital-intensive corporations would likely leave.
(An executive of one of the companies stated privately that it would leave.) The labor-intensive
companies might remain. It seems quite clear that any major reduction or restructuring of the credit
would result in the loss of jobs.
The issue caught some of the interest groups by surprise, and they were faced with the task of
formulating and implementing a nonmarket strategy to deal with the Clinton administrations bill.
The issue is clearly one of distributive politics with the complication that it involves the longstanding issue of commonwealth status versus statehood. In plebiscites, Puerto Ricans have
narrowly rejected statehood. If Puerto Rico were to become a state, the tax credit would be
eliminated. Conversely, if the tax credit were eliminated, one of the obstacles to statehood would
be eliminated.
The case illustrates the nature of distributive politics and the conflicting interests even among
businesses. The case also indicates the nature of political compromise. The main feature of the
case, however, is the formulation and implementation of political strategies. The institutional focus
is on Congress and the office of the president. Both representational and informational strategies
were used. The informational dimension centers on how many firms would leave if the tax credit
were eliminated.
The alignment of interests in this case depends on the alternative under consideration. Regarding
the alternative of defeating the Clinton plan, virtually all mainland corporations, with the possible
exception of the some of the most labor-intensive corporations, favor the status quo over the plan.
This results because the total tax credits would be reduced by $6.7 billion. The opposition to the
plan is strongest among the capital-intensive companies that stand to lose because of both the
reduced credits and the restructuring of the credit based on wages. Presumably all companies
oppose the elimination of the credit on interest earned on deposits in Puerto Rican banks (even
though there is an offset based on equipment). Mainland companies are already organized for this
political battle, and PRUSA is able to represent their interests in a relatively unified manner. The
magnitude of the tax credits at risk means the demand for political action is high, and the costs of
supplying political action are low. The strategy issue is thus how to effectively participate in the
politics of this issue.
The interest group that stands to benefit from the Clinton plan is taxpayers, but they are too costly
to organize so they will not participate. The benefits of the Clinton plan are thus widely-distributed
and the costs are concentrated primarily on the mainland corporations and on the Puerto Ricans
who may lose their jobs. In the context of the Wilson-Lowi matrix, this is a case of entrepreneurial
politics, and Clinton is the entrepreneur. The support within Congress for the plan comes primarily
from those who seek to reduce the federal deficit and from those who want to restructure the credit
to reduce the gain to those companies that create few jobs. On the same side of the issue as the
corporations are those who are concerned with the impact of the Clinton plan on the Puerto Rican
economy. It is this alignment that provides the basis for the representational strategy of the
mainland companies. (Organized labor was in a difficult position in this case because it was
concerned about more jobs fleeing for the island, but it could be brought off by including a
provision restricting runaway jobs.)

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The political strategy of the mainland companies focused on showing that their interests were
aligned with those of Puerto Ricans, and implementation of this basic strategy rested on two pillars.
One was popular support from Puerto Ricans on the mainland, and the other was support of the
current Puerto Rican government. To obtain the support of Governor Rossello, PRUSA both
directly lobbied the government and helped support public expressions of opposition for the
Clinton plan. The Rossello government then withdrew its initial support for the plan. This was a
victory, since without the governments support it would be difficult to use grassroots strategies on
the mainland.
The support of the Rossello government was not sufficient, however, and the plan passed in the
House. The likelihood that the plan would pass had now increased substantially, and hence the
formula used to determine the credits became as important as the amount of the credits.
Attention then turned to the Senate and the second component focusing on the Puerto Rican base on
the mainland. The first step was to demonstrate support by mainlanders of Puerto Rican heritage.
The Puerto Rico day parades presented a natural opportunity. The second step was to enlist the aid
of influential allies including Rostenkowski, Moynihan, and Bradley. PRUSA and individual
companies with operations on the island already had relationships with these members, so access
was easy. With their constituents showing opposition to the Clinton plan, their support was
relatively easy to obtain. The third step was to enlist the aid of the Hispanic caucus, which was also
relatively easy to accomplish.
Because of the split between capital-intensive and labor-intensive firms, the strategy in the Senate
focused on giving the mainland companies a choice between the Clinton formula and one that
would base the credit on income, as in the current system. This was an easy choice for the Senate
which voted in favor of giving a choice. In doing so $2.7 billion in credits were preserved.
The next step was to protect the Senate version in conference. This involved generating pressure
on Rostenkowski, whose committee had jurisdiction over tax issues. Constituent pressure and
lobbying by the Hispanic caucus led Rostenkowski to agree to the Senate bill.
Teaching the case:
The discussion can be guided by the following questions.
1. What is the nature of the present tax credit? If the credit were eliminated, would mainland
corporations close their operations in Puerto Rico? What then might happen?
2. Are Puerto Ricans likely to be solidly in support of Section 936?
3. What are the principal interests affected by this issue and how are they aligned? What is the
nature of the politics; i.e., Wilson-Lowi matrix?
4. What are the key elements of the nonmarket strategy of the mainland corporations? (Note that
the market strategies of these companies would be implemented only after this issue is resolved.)
5. How effectively was that strategy implemented?
6. Was the nonmarket strategy of the corporations responsible?
7. Would it have been irresponsible to abandon operations in Puerto Rico if the Clinton plan had
passed?

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Developments:
The case describes the bill that was passed.
In the November 1993 plebiscite, 48.4% voted for commonwealth status, 46.2% for statehood, and
4% for independence. Another plebiscite was held in December 1998, and statehood backed by the
New Progressive Party received 46.5%. The Popular Democratic Party supported a vote for none
of the above, which received 50.2% of the vote. Commonwealth status was preserved.
In the December 13, 1993 issue of Fortune, Puerto Rico had an advertising section, and one of the
pages headlined 936 Slimmed down but still powerful. The ad also stated that Puerto Rico was
reexamining its tollgate tax.
In 1996 Congress repealed the Section 936 tax credits, which are to be phased out over 10 years
under Section 30-A. Governor Sila Maria Calderon, who took office in 2001, sought reinstatement
of the tax credits.

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Chapter 7
Formulating Political Strategies
This chapter focuses on the formulation of strategies for participating effectively and responsibly in
the politics of nonmarket issues. The focus is on legislative issues, but the framework and
approach are applicable more generally.
At about this point in the book, students may begin to wonder whether political action by firms is a
good thing. Three basic responses can be given. The first is that firms and their managers do it,
so it is worth studying how they do it. Second, political action by firms is legal and constitutionally
protected. Third, the appropriate limits within the realm of legal activities is in the domain of
ethics. The second section of Chapter 7 raises these issues and provides a partial response. That
response is largely based on the law, and ethics concerns are discussed in Chapter 20. A lecture on
responsible political action that expands on the material in the text would be good.
The chapter is primarily concerned with formulating political strategies and illustrating political
strategy formulation through a set of examples. The discussion of strategy formulation is general
and builds on the treatments of institutional characteristics and political analysis from the two
previous chapters.
The perspective taken is that strategy formulation is the responsibility of management and not of
political consultants or advisors, although the latter can provide important inputs to the process and
can assist in implementation. A lecture could emphasize this point and focus on the components of
strategy formulation as illustrated by the examples presented in the chapter. The links to political
analysis and institutional knowledge should be emphasized to make it clear that the material in Part
II is an integrated whole rather than a collection of independent components. One aspect of the
political strategy formulation process that might be emphasized is the importance of developing
political assets such as the rent chain.
A lecture can focus on the process of strategy formulation as illustrated in Figure 7-1. This figure
emphasizes that strategy formulation is based on the framework for analysis presented in Chapter 6
and the institutional information presented in Chapter 5. The Echelon and Home Automation
Standard case in Chapter 10 concerns an issue that began with Congress, was delegated to a
regulatory agency, then moved back to the Congress, and then returned to the regulatory agency.
The concept of a rent chain is important as a foundation for political strategies and should be
emphasized in a lecture. The rent chain can be important in the implementation of the three basic
types of political strategies: representational, majority building, and informational. The basic
strategies can be used alone or can be combined. For example, in the Drexel Lambert Burnham
and Junk Bonds Politics case the firm used an informational strategy focusing on the use of junk
bonds in financing high growth companies, and it supported that strategy by forming a grassroots
group of its clients to bring that message to members of Congress.

131

Majority building strategies involve vote recruitment and agenda setting. The concept of pivotal
voters is important and is well-illustrated in the Federal Express (A) case. The concept can also be
applied in the Summertime in the European Union case in Chapter 5.
Informational strategies are implemented by lobbying and public advocacy as considered in
Chapter 8. These strategies are illustrated by the China and Most Favored Nation Status example,
and by the cases listed above. Informational strategies are often a component of a broader strategy
encompassing representation and majority building for issues considered in legislatures. For issues
considered in regulatory and administrative institutions, informational strategies are often the
centerpiece, although as indicated in Chapter 10 representational and majority-building strategies
are frequently used to pressure regulatory agencies through the legislature.

Cases
Federal Express
This case provides an opportunity to apply the analytics of a majority-building strategy through
vote recruitment. Federal Express found itself in difficulty when the bill to eliminate the Interstate
Commerce Commission may have inadvertently changed the law under which its employees could
be organized. Federal Expresss objective was to have a provision inserted in a bill that would
clearly designate it as an express company, which was the origin of the company, and hence put it
clearly under RLA jurisdiction. To accomplish this, its allies inserted the provision in a conference
committee report, but when the bill encountered a filibuster in the Senate, it faced a more serious
problem. It had to recruit 60 votes to have cloture invoked, after which the bill would proceed to a
vote and certain passage. That is, it had to deploy a supermajority-building strategy and recruit
sufficient votes for it to be successful. Although organized labor opposed the alternative sought by
Federal Express, it had already executed its strategy, and the final move in the Senate belonged to
Federal Express. This stage of the labor organization issue is thus characteristic of client politics
with only Federal Express active.
The basic principles of vote recruitment are to recruit only those votes necessary to win and to
recruit those votes that are least-costly. The least-costly votes are those of Senators who are only
mildly opposed to RLA jurisdiction. The instrument of Federal Expresss strategy was politicallyvaluable resources such as favors and vote trades on other legislation.17
The following answer the preparation questions:
1. Senators 46 through 100 prefer b to q, since b is closer to their ideal point than is q. Since they
will vote for b anyway, they do not require vote trades or support. (This group includes Federal
Expresss allies as well as others.) Senators 1 through 40 prefer q to b, and their vote is not needed
to invoke cloture, so they will receive nothing.
17

This is not a description of Federal Expresss analysis, but instead is an analytical characterization of principles of
vote recruitment strategies.

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2. This is the complement of question 1. The votes of senators 41 through 45 are needed to invoke
cloture. Senator 45 is indifferent between q and b, since they are equidistant from her ideal point.
She needs only a tiny favor or a low-value vote trade to vote for b. Senators 41 through 44 will
require a more valuable vote trade or favor for their votes.
3. Of those senators whose vote must be obtained with a vote trade or a favor, more must be given
to 41 than to the others because 41 prefers q to b more strongly than do 42, 43, 44, and 45.
4. Several principles are reflected in these answers: a) Those who will support you in any event do
not need special favors on the issue (other than maintaining relationships, etc.). b) Do not waste
your time, resources, and attention on those who are strongly opposed. c) Target pivotal legislators
(41-45). In this case, those pivotal voters are the one who are mildly opposed to your alternative.
d) The value of favors or vote trades required is greater the more opposed the pivotal voter is. e)
Agenda setting explains where b is located.
The outcome:
Federal Expresss nonmarket strategy was successful, and the vote on cloture was 66 to 31.18 One
interpretation of this situation is that Federal Express figuratively recruited some additional votes as
insurance; i.e., to provide for the possibility that it might have misestimated the preferences of
legislators. The bill itself then passed the Senate 92-2. Eventually the House passed the bill, too,
and the president signed it.
Implementation of the strategy:
The strategy deployed by Federal Express was to focus on pivotal legislators, who in this case were
Democrats who traditionally would vote with organized labor on such an issue. Those senators
included Ernest Hollings, Max Baucus, Bennett Johnston, and Tom Daschle. The following table
presents their ratings (on a scale of 0 to 100) by two interest groupsCOPE (the AFL-CIO) and
COC (Chamber of Commerce). (These ratings are explained in Chapter 8.) A high rating by COPE
means that the senator votes in line with organized labor on issues of importance to unions. A high
rating by COC means that the senator votes with business on issues important to business. The
issues used in the settings by the two groups are not the same, so a senator such as Bennett
Johnston can have favorable rating by both business and labor.
1994
Baucus (Montana)
Daschle (South Dakota)
Hollings (South Carolina)
Johnston (Louisiana)

COPE
100
63
71
75

COC
32
37
46
53

Federal Express had to win two votes. The first was to overrule the Senate parliamentarian who had ruled that
insertion of the provision in conference committee exceeded the authority of the conferees. The vote to overrule was
56-39.
18

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Federal Expresss strategy was to build on the relationships it had developed over time, to lobby for
the provision, and to enlist the aid of its allies. Federal Express had a continuing set of issues
involving Congress, so it was experienced both in addressing nonmarket issues and in deploying a
broad set of nonmarket strategies to obtain its objectives. As Doyle Cloud, vice-president of
regulatory and government affairs explained, We have issues constantly in Washington that affect
our ability to deliver the services our customers demand as efficiently as possible.19 For all the
issues on its agenda, during the first six months of 1996, Federal Express spent $1,149,150 on
lobbying, including $367,000 on outside law firms. Using outside firms is common, particularly for
their contacts and established relationships with government officials. Federal Express also has on
its board of directors Howard H. Baker, Jr., former Republican leader in the Senate, and George J.
Mitchell, former Democratic leader in the Senate. Federal Express also was the fifth largest
campaign contributor in the 1995-1996 election cycle, contributing $600,500 through August 30,
1996. Also, on a regular basis Federal Express made its four corporate jets available to members of
Congress. Although the members were required to reimburse the company at the equivalent of
first-class air fare, the corporate jets provided privacy and convenience to their passengers. In most
cases, the flights took members of Congress to fundraising events. Mr. Cloud said that during
political seasons, Federal Express might fly a group of lawmakers about once a week.20
Federal Express also benefited from the efforts of its allies in the Senate, many of whom were from
the South. In addition, former Senator James R. Sasser of Tennessee, the ambassador to China in
1996, was said to have chatted with Senator J. Bennett Johnston about the Federal Express
provision.21
Senator Russell D. Feingold, Democrat of Wisconsin who voted against Federal Express, assessed
its overall strategy: I was stunned by the breadth and depth of their clout up here. ...The sense I
got was that this company had made a real strong effort to be friendly and helpful to Congress. ... In
these informal conversations [with senators], people mentioned that they had flown in a Fedex
plane or gotten other favors.22
The extent of Federal Expresss nonmarket efforts are surely greater than those of most firms, and
in part that is explained by its operations in a semi-regulated business. Although its activities
may be pushing the envelope of responsible nonmarket action, the principles of building a majority,
developing access, lobbying, and providing politically-valuable resources as a means of recruiting
votes are important components of the nonmarket strategies of firms, labor unions,
environmentalists, and other interests.
Teaching the case:
The following questions can be used to structure the discussion:
1. What must Federal Express accomplish to return to clear RLA jurisdiction?
2. Who will set the agenda for Federal Express?
The New York Times, October 12, 1996.
The New York Times, October 12, 1996.
21
Ambassador Sasser had been retained as a consultant by Federal Express prior to his confirmation as ambassador.
(The New York Times, October 12, 1996.)
22
The New York Times, October 12, 1996.
19
20

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3. Which votes should Federal Express recruit? Which are more or less costly in terms of vote
trades by allies or support from Federal Express?
4. Is there any reason to recruit more than 60 votes?
5. In terms of implementing a vote recruitment strategy to build the needed supermajority, which
actual senators should be targeted? What are their characteristics?
6. What if any should be the limits on Federal Expresss provision of support or politicallyvaluable resources?
Recent developments:
The battle between organized labor and Fed Ex took another turn in December 2000. Federal law
allows an individual to ask the Department of Labor for an opinion letter on a workplace situation.
A Washington lawyer with ties to UPS and likely the Teamsters as well was believed to have asked
for the opinion.23 (The Teamsters have organized approximately 200,000 UPS workers.) The
situation described in the request closely resembled the situation of pick-up and delivery drivers for
Caliber Systems, Inc. business Fed Ex acquired in 1997. The letter basically indicated that the
drivers in the hypothetical situation were employees, whereas Fed Ex claimed they were
independent contractors. The Teamsters argued that the letter gave them a legal instrument to use
in their next organization attempt. Fed Ex dismissed the Teamsters assertion. Apparently, the letter
would only be of use if an actual dispute arose between the Teamsters and Fed Ex.

CSN and Steel Antidumping (A)


Transparencies are available for this case csnslides.ppt.
This case can be used either in conjunction with Part II of the book or with Chapter 17 on
international trade. Chapter 17 provides information on antidumping, and the Chapter 17 case
Cemex and Antidumping provides more information on the U.S. administrative process for deciding
antidumping cases. That case also provides information on how an exporter can attempt to
influence the processin that case without success. The CSN and Steel Antidumping (A) case
focuses on the position CSN found itself in as a result of a variety of forces outside its control. The
transparencies for this case include both trade and CSN information.
As the case indicates, steel is a commodity that moves freely around the world in response to
market opportunities. The United States is a net importer of steel, so large quantities of steel are
imported particularly when demand is strong in the United States. Also, as the case indicates, CSN
opportunistically responds to favorable market opportunities, exporting a third of its total
production. When a crisis arises as in Asia and demand for steel in those countries drops, the steel
companies that had been exporting to Asian markets look for other markets in which to sell their
steel. The United States market is frequently the recipient of those exports, driving down prices.
23

The Wall Street Journal, December 22, 2000.

135

The U.S. steel industry, particularly the major integrated steel companies, is inefficient by world
standards, so U.S. steel companies lose sales during these periods. To protect their interests,
companies use their rights under U.S. trade law to file antidumping petitions. These petitions are
consistent with GATT/WTO rules.
The domestic interests are not just the steel companies but as importantly the United Steel Workers.
The union has lost hundreds of thousands of jobs in the past few decades. The union is also active
politically and regularly works in Washington for relief from imports. Because of the UAWs
successful efforts on behalf of Democrats in the 1998 congressional elections, Vice President Gore
catered to the union to solidify their support for his run for the presidency.
The case focuses on CSNs situation as governed by the U.S. standards for antidumping cases.
CSN does not have a rent chain in the United States, with the exception of customers. Those
customers, however, can simply switch to another supplier of the commodity, so given this
substitute they may have little incentive to support CSN itself. The importers more generally will
oppose duties on imported steel, but there is little they can do about an antidumping petition, which
is governed by administrative procedures.
The cumulation standard is reasonable when it is not possible to determine which tons of steel are
the cause of the material injury to the domestic industry. That is, if steel is a commodity, then one
ton of steel is no different from another ton of steel, so all the imported steel is responsible for the
injury. CSN tried, but to no avail, to separate Russian steel. Whether that steel should be
considered as a separate product is unclear, but the U.S. agencies concluded that it should not be. If
information were available on the world supply curve for steel, then it might be possible to
determine which tons would be imported before others. The duty assigned to Japanese imports was
greater than the preliminary duty assigned to Brazilian imports, and this could suggest that U.S.
importers would import Japanese steel before Brazilian steel. The Brazilian steel would then be
more responsible for the injury. This analysis, however, may not be right because the duty is
determined by comparing the price in the Japanese market with the price at which Japanese steel
producers sell in the U.S. market. If the price of steel in the Japanese market is higher than the
price of steel in the Brazilian market, then the above analysis might not be correct.
The cash deposit requirement seems quite reasonable. The deposit is required only in the event of a
preliminary finding of material injury in favor of the petitioners and is refundable if the case is not
decided consistent with that finding. The deposit is simply a means of collecting the duty from
continuing imports after the preliminary finding. Since final decisions are generally consistent with
the preliminary finding, this is a reasonable requirement. The only cost to importers is a delay in
having the deposit returned if no dumping margin is eventually imposed. Since interest is paid on
the deposit, this is basically a fair gamble for an importer. Importers that are risk averse would stop
importing the steel, which is what they did. In contrast, in the Cemex case referred to above,
Cemex itself paid the deposit. CSN could do this, as well. CSN, however, understands the U.S.
antidumping procedures and knew that once a finding of preliminary injury was made, duties
would be imposed. CSN thus decided not to import to the United States.
The strategy alternatives for CSN include (1) appealing the ITC and ITA decisions, (2) undertaking
political action in the United States, (3) pressuring the Brazilian government to retaliate against the

136

United States, (4) negotiating a suspension agreement through the Brazilian government, and (5)
doing nothing. Alternative (3) would violate GATT/WTO rules, and the Brazilian government is
not likely to take such a step. Appealing the decision is possible but is unlikely to be successful.
Steel importers from Brazil, Japan, and Russia would have great difficulty conducting a political
strategy in the United States, and since they have little in the way of rent chains in the United
States, there is little that they could accomplish. Their best hope politically is to join with steel
importers, but even they will have little impact on the ITC-ITA administrative process. The best
alternatives are (4) and (5). As indicated in the (B) case, Brazil and the steel companies chose (4).
One interpretation of the suspension agreement is that Brazil may have panicked when it saw the
duties imposed on Japanese steel imports. The U.S. International Trade Commission and the
International Trade Administration, which decide the cases, subsequently found in favor of the
petitioners in only about half the cases. What would have happened to Brazilian steel exports is not
clear, although the outcome may have gone against Brazil as described below.
Chapter 17 provides additional information on subsequent developments with regard to steel
imports. The following (B) case advances the issue and describe the outcome.

137

CSN AND STEEL ANTIDUMPING (B)


On July 6, 1999, the Department of Commerce (DOC) issued a final determination with
approximately 40% margins for both CSN and COSIPAS/USIMINAS, along with an agreement
with Brazilian steel makers and the Brazilian government on antidumping and countervailing
duties. Brazilians steel producers had the benefit of seeing the Japanese ruling while they were in
negotiations with the DOC on a settlement. Since the imports had been cumulated with the
Japanese, the Brazilians felt that defeat was imminent in the ITC. However, this did not mean that
CSN had to settle the case. They could have appealed to the US Court of International Trade (and
then higher still) or could have simply accepted the rulings of the ITC and the margins imposed by
the DOC. However, throughout this process, any sales of steel to the United States required that the
importers place in an account the amount equal to the proposed duties. They would receive this
money back only if they were exonerated of the charges. As a result of this requirement, imports
had fallen to virtually zero, and could remain at that level for perhaps two more years, as the case
wound its way through the review process.
The agreement, known as a suspension agreement, allows Brazilian steel imports to resume in
October 1999 at a minimum price of $327 per ton for a basic hot rolled coil. As William Barringer,
the attorney for the Japanese and Brazilian firms, points out: () the price provided for in the
suspension agreement () is above both current market prices (World Steel Dynamics estimates
spot market prices at $270-290 per metric ton) and above prices in the Brazilian market. In fact, exmill prices in Brazil for the same basic hot-rolled product are $255 per ton; these prices are well
above fully allocated costs of between $200 and $225. Thus, from a pricing perspective, the
protection afforded by the suspension agreement is greater than the protection required under the
antidumping law. Yet, because of the way the system functions and creates enormous contingent
liabilities for importers, an agreement at these high prices is preferable to an antidumping duty
order even if the latter would permit more competitive pricing.
The agreement is known as a suspension agreement because it supersedes any subsequent negative
findings by the ITC. However, if the ITC issues a ruling favorable to the Brazilian companies, then
that ruling takes precedence. In August of 1999, the ITC found that material injury existed, as
expected. However, its ruling, which would have enforced the DOC duties, is suspended so long as
the agreement reached with DOC is honored.
CSN also reacted on the market front: as the Asian crisis abated, it shifted exports to Asia and kept
overall balance between domestic and export shipments approximately unchanged. In 1998, 37% of
its exports went to NAFTA countries and only 8% went to Asia. In the first-half of 1999, 20% went
to NAFTA countries, while 47% went to Asia. The devaluation of the Real helped in this
reorientation of exports. Furthermore, it made a successful return of CSN on the US market more
likely.
In the Senate, the steel quota bill was defeated on June 22, 1999, gathering only 42 votes. Some
Midwestern senators were concerned that protectionist legislation on steel in the US would lead to
retaliation from other countries, particularly in agricultural products. The White House also pointed
out that regulatory actions through the ITC and ITA had already stemmed the flow of imports, and

138

that both the House and Senate had passed legislation enacting loan guarantees for US steel
producers, so that further legislative action was no longer necessary.
Finally, in mid-August 1999, three days before the scheduled ITC final determination on Brazilian
steel imports, five US steel companies challenged the July suspension agreement by filing suit
before the Court of International Trade.
Preparation Questions
1. Evaluate CSNs integrated strategy? Should CSN have acted on the legislative front? Explain.
2.Why did US steel manufacturers challenge the suspension agreement? Why are such agreements
unattractive to the domestic industry?
This case was prepared by David Primo and Professor Romain Wacziarg. Copyright 1999 by the
Board of Trustees of the Leland Stanford Junior University. All rights reserved. Reproduced with
permission.

139

Comments and developments:


The outcome of the 1999 case is described in the transparencies. Eventually, duties were imposed
on Brazilian steel because Brazil was found to have violated the suspension agreement.
The steel import issue continued, but President Clinton took no further action. Some commentators
speculated that President Clinton did not provide relief for the steel industry because of a rift with
Vice President Al Gore.
In 2002 in response to the petitions by the steel industry and political action by the companies and
labor unions, the Bush administration took the extraordinary action of imposing temporary tariffs
on certain steel imports under Section 201 of U.S. trade law. As indicated in Chapter 17 the Section
201 action was the first in 30 years. The ostensible purpose of the tariffs was to allow the steel
companies to consolidate and improve their efficiency. The tariffs were to last for three years and
were applied selectively to countries. Developing countries were exempted, and the tariffs were
primarily applied to industrialized countries and advanced developing countries. The largest
impact was on the European Union with 3.74 million (metric) tons affected followed by South
Korea with 1.75, Russia 1.44, Japan 1.32, Turkey 0,52, China 0.48, Taiwan 0.45, Ukraine 0.20, and
India 0.18. The countries exempted from the tariffs included Brazil,
The tariffs had been opposed by steel consuming industries which had formed the Consuming
Trade Action Coalition.
Part of the assistance sought by the steel industry and United Steel Workers Union was to cover the
cost of health and pension benefits for 600,000 retired workers. The estimate of the cost over the
next ten years was over $10 billion. The problem was that the current 160,000 workers in the
industry were unable to cover the benefit obligations. The Bush administration, however, refused
to assume the benefits obligations.
Prior to the decision of the Bush administration the European Union sought to negotiate with the
United States. The EU proposed that the U.S. impose a 40% tax on all steel sold in the country.
The proceeds would be used to cover consolidation of steel companies and to pay for retiree health
and pension obligations. The EU also pledged to cut subsidies and capacity worldwide. The EU
pledged to reduce capacity by 4%. The Bush administration rejected the proposal, since it would
not result in a sufficient reduction of worldwide steel capacity.
The EU took immediate action by filing two actions within the context of the WTO. First, it filed a
complaint under the WTO dispute resolution process. Second, it filed a complaint that the U.S. had
selectively imposed tariffs under the safeguards procedures. The direct effect of the tariffs on EU
steel producers would be small, representing 2.5% of EU production. The principal concern of the
EU governments was the low cost steel that had been exported to the United States would be
diverted to the EU forcing prices down. This could substantially affect EU steel producers.
Maria Silva Bastos Marquez, president of CSN and head of the Brazilian Steel Institute, reacted to
the imposition of tariffs by the Bush administration in 2002. The New York Times reported that she

140

said that the steel sector stood to lose $1 billion in sales over the next three years because of the
tariffs. Mills will postpone plans for heavy investments to expand production, she said. Union
leasers have said that up to 5,000 jobs will be affected. In a conference call with reporters, Ms.
Bastos Marquez said that the steel industry had proposed responding to the American move by
raising Brazils tariffs on some finished steel products imported from the United States and
elsewhere to protect the local market from what she expects will be a flood of inexpensive steel
diverted from the American market.24
CSN was represented by the law firm of Wilkie Farr and Gallagher, which frequently represents
exporters in trade disputes. The domestic industry is frequently represented by the Washington
office, headed by Alan Wolff, of Dewey Ballantine. For example, in the Chapter 17 case The
Kodak-Fujifilm Trade Dispute, William Barringer of Wilkie Farr represented Fuji Film and Wolff
represented Eastman Kodak. Both are effective advocates for their sides, and their public
statements should be viewed as advocating the interests of their clients. The Washington office of
Dewey Ballantine refers to itself as a Democratic firm, since Wolff and others served in the
government in Democratic administrations.
In the spring of 2002 National Steel filed for bankruptcy.

The Bermuda Triangle


This case is intended to demonstrate the interaction between market and nonmarket analysis. The
economic principles to be applied in the case are 1) valuation and risk, 2) rants and the elasticity of
demand, 3) pricing in response to a decrease in costs, 4) market equilibrium responses to lower
pricing in a market, and 5) bargaining. Analysis would include some decision tree display of
strategy alternatives and options. The nonmarket analysis would focus on the incentives for
nonmarket action, the possibility of collective action, identification of the relevant institutions and
officeholders, nonmarket strategies, and predictions of outcomes.
Clearly, if there were substantial value created by moving a property-casualty business to Bermuda
more companies would be expected to move there. Similarly, if one Bermuda company can gain
from this type of move, so can other companies. Some U.S. companies, particularly those with low
taxable gains, could move to Bermuda, and others could sell to Bermuda companies. This could
lead to a race to the bottom. This would likely stimulate action by the Department of Treasury
and in Congress. The media is attuned to these issues because of Secretary Summers actions.
Economic theory predicts that ACE would reduce prices somewhat, which would strengthen
pressures for a race to the bottom. From a nonmarket perspective if ACE lowers prices, the
incentive for U.S. companies to take nonmarket action would be stronger.
If ACE lowered its rates to capture greater market share, would the funds available for investment
increase? The answer depends on the elasticity of demand, which for a competitive industry should
be high.
24

The New York Times, March 14, 2002.

141

Paying a high price for Cignas business would be OK if it were the only one taking advantage of
the tax advantage, since the nonmarket issue then might not arise. More companies would be
expected to follow suit, however.
Both Cigna and ACE understand the tax advantage and hence would bargain under complete
information. A prediction of bargaining theory is that the premium paid for Cignas propertycasualty business would be half the increase in value from locating the business in Bermuda rather
than in the United States (the Nash bargaining solution).
This case has been used as an examination question. The following are comments on what
constitutes a good answer. Characteristics of a good answer are:
1. recognizing the nonmarket issue and its relationship to the market issue.
2. using conceptual frameworks and using them correctly to analyze the issues
3. recommendations/answers that follow from the analysis
4. recommendations that speak to the principal issues
5. answers that are reasonably comprehensive
6. answers that integrate the market and nonmarket concepts and analysis
The pricing decision has both a market and a nonmarket dimension. The market dimension
pertains to how much premiums will increase and what the response of other insurance companies
will be. The nonmarket dimension is the effect on the rents of competitors and the incentive it
provides for nonmarket action. On the market side ACE would gain considerable market share if it
were to lower its price, and given that demand is elastic, total premiums would increase. That
would increase the return on the investment of those premiums, which would enjoy the tax
advantage. In capturing the tax advantage, ACE would be reducing the demand of competitors.
Competitors would be expected to reduce their prices somewhat in response, but probably not to
match ACE, since Cigna has a small share (less than 2%?) of the market. The competitive response
would reduce the gain to ACE, but ACE could well gain on net. (The set-up in the case hints at
that.) Other insurance companies have the substitute (see Chapter 6) of moving to Bermuda.
Students are not expected to do any of what is in this and the following paragraphs. The economics
of a price reduction are quite complicated, but it is clear that ACE could benefit from a modest
price decrease, whereas its U.S. competitors would surely lose. Suppose that absent a price cut the
price p was equal to the claims c and the return on the premiums is r. The profit S then is
S = pq(p)(1+r)-cq(p) = cq(c)r,
Where p=c and q(c) is the quantity demanded.
Suppose ACE reduced the premium to 0.99c and demand increased by 5%. Then, the profit is
S = .99c q(.99c)(1+r) c q(.99c)
= .99c (1.05)q(c)(1+r) - .99c (1.05)q(c).
= ,99(1.05)cq(c)r
= 1.0395cq(c)r.
This is an increase compared to that above. It would still be an increase in profits if demand
increased only by slightly more than 1%; i.e., demand is elastic.

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The nonmarket dimension is that the competitors are hurt by having to reduce their prices, and if
they do not reduce prices they lose sales and hence earnings on the premiums. Their loss of rents
could be substantial.
The pricing decision thus involves a tradeoff of market advantage versus a nonmarket risk
The interests might not mount a nonmarket campaign if they were certain that only ACE would
acquire a U.S. company and no U.S. companies moved to Bermuda. An important positive issue is
whether other U.S. insurance companies will move to Bermuda or whether other Bermuda
companies will acquire U.S. companies. Both of these seem likely given the substantial tax
benefits available. The insurance companies that are likely to move are the younger companies
most of which would likely be small. This conclusion must be tempered by the possibility that the
remaining U.S. companies or the Treasury secretary would lead a successful nonmarket campaign.
(A number of companies did announce their intent to move and several already had moved.) These
companies could then also reduce their prices. This could result is a flood of companies moving
their headquarters and perhaps more to Bermuda. The risk that the tax breaks will be rescinded
increases with the number of U.S. companies that move to Bermuda or sell business units to
companies in Bermuda.
The nonmarket issue is the tax loophole from which ACE hopes to benefit. This issue is early in its
life cycle. It has been identified and interests are starting to recognize the issue and beginning to
form interest groups. The legislative stage could commence soon.
The operable issue is the closing of the loophole, and the beneficiaries include the U.S. insurance
companies that do not move to Bermuda, insurance agents who stand to lose business to ACE, and
taxpayers who will benefit because the increased tax collections would make a tax cut more
likely. The interests that would be hurt by the alternative are the Bermuda companies, those U.S.
companies that would move to Bermuda, U.S. companies like Cigna that would sell business units
to Bermuda companies, and consumers who would not have the opportunity to benefit from the
lower insurance prices.
The relevant institutions are Congress and the Clinton administration. The Treasury is an interest
in this case, since its reputation for eliminating tax abuse is at stake.
The rents of the remaining U.S. insurance companies are large, and those companies have no
substitute. (Obtaining a subsidy from the U.S. government is out of the question.) The distributive
politics spreadsheet indicates that the likely nonmarket action by the proponents of rescinding the
tax break is substantially greater than can be mustered by the opponents. For example, the U.S.
insurance companies are well-organized, have low costs of taking nonmarket action, and have large
rent chains (agents) with good coverage. Their stakes are also high. The newer, and smaller,
insurance companies that would move likely have small rent chains.
The politics are characterized by concentrated benefits for the mainline U.S. insurers, concentrated
costs for the Bermuda companies and the smaller U.S. companies that would like to take advantage
of the tax break. In the Wilson-Lowi framework this is interest group politics, but it is more

143

complicated because the interests of taxpayers are represented by a political entrepreneur in the
form of Treasury. Hence, the politics are both interest group and entrepreneurial.
How likely is the possible nonmarket challenge? It is highly likely.
The U.S. companies will use lobbying as their primary nonmarket strategy instrument. The
messages are that this is an unwarranted tax break that is devoid of economic substance and that it
places U.S. companies at a competitive disadvantage. The U.S. companies will label the practice
tax abuse.
The lobbying would be of Congress, the Department of Treasury, and the Clinton administration.
The relevant committees within Congress are the tax committeesWays and Means and Finance in
the House and Senate, respectfully. The insurance companies can enlist allies from the states (e.g.,
Connecticut) where they are located. (Recall that the reading on the fly-in discusses insurance
companies and mentions Senator Joe Lieberman.) The focus on Treasury should be to encourage it
to act aggressively and quickly to stop this tax abuse.
The insurance companies could also mount a grassroots campaign by mobilizing insurance agents
who stand to lose business due to ACEs acquisition of Cignas business.
The companies could also use a public advocacy campaign directed at Congress and the Clinton
administration. This could involve ads in Roll Call and the Washington Post.
The forces pushing for elimination of the tax abuse should be strong and hence will be able to
mount an effective campaign. That campaign is likely to be more aggressive if ACE were to reduce
prices for insurance. The probability is fairly high that the U.S. companies and Treasury will
prevail. Hence, ACE should be willing to offer significantly less than $3.5 billion. (ACE paid
$3.45 billion for Cignas business.)
The risk to ACE is that those who are harmed will take nonmarket action to rescind the tax breaks.
This can easily be done either by (1) prohibiting the transfer of premiums (but this risks being an
international trade violation), (2) simply taxing the earnings on the premiums at U.S. tax rates (this
might be problematic), or (3) increasing the excise tax on premiums transferred out of the U.S.
This might be the easiest means. ACE, however, is advantaged by being on the side of the status
quo.
Integrated strategy
An integrated strategy for ACE should include (a) a pricing strategy, (b) an ex ante nonmarket
strategy intended to reduce the likelihood of a nonmarket challenge to its acquisition, and (c) a
nonmarket strategy to deal with the challenge if it occurs. Since the nonmarket challenge is so
likely, students may combine (b) and (c). This may not involve any significant reduction in prices,
at least at this point in the issue life cycle. The purpose of this is to avoid stirring up the proponents
any more than they are currently stirred up. ACE can also use this as a bargaining lever on price
with Cigna.

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The framing of the issue is potentially important. The proponents of rescinding the tax break will
label it as tax evasion and tax abuse.
ACE can argue that owning Cignas business allows it to reduce prices in the U.S. which benefits
consumers. The problem is that these consumers are also taxpayers, and they lose on the tax side.
ACE can attempt to mobilize insurance agents that sell Cigna insurance, but ACE is surely
outnumbered here.
ACE can also argue that a substantial part of the tax break is returned to U.S. investors through the
purchase price for Cignas business. This, however, is concentrated on the shareholders of Cigna,
who are represented only by Cigna.
In addition to its strategy of attempting to counter the proponents in U.S. institutional arenas, it
should attempt to use international law and international trade law to at least add complexity to the
issue. The international law hook might be that Congressional action would be blocking an
allowable transaction.
If ACE were to acquire Cigna, it may have some synergies in operating a property-casualty
business in the United States, but there is nothing in the case to hint at that.
How much should ACE pay? Students need not speak to this issue, but if they do, they should take
the nonmarket risk into account. In the absence of nonmarket action, if there are several possible
buyers that can take the tax break, then the price would be bid up close to $3.5 billion. If there is
only one possible purchaser, then Cigna and the purchaser would be able to split the tax advantage.
There may be an issue of the capital gains tax on Cignas sale. Whatever this tax would be, the
amount would be deducted from the tax advantage and shared between buyer and seller.
ACE has a significant rent chain in the U.S. that it might be able to mobilize, but it is important to
note that jobs are probably not at risk here, since it is a tax issue that largely involves transfers. If
anything, jobs would be increased if prices were lowered.
Suppose ACE acquired Cignas business and either the U.S. insurance companies began to mount a
nonmarket strategy or the Treasury Secretary launched an attack on the acquisition. What should
ACE do? One strategy is to wrap itself in the legality of the acquisition in terms of both U.S. and
particularly international law. ACE, for example, argued that many other countries had lower taxes
on insurance companies than did the United States. Bermuda was thus being unfairly singled out.
It may also be possible to use international trade law by arguing that rescinding the loophole
violates some aspect of the WTO rules. The best hope may be that international trade law does not
view differences in tax rates as a basis for restraining trade, Hence, the U.S. impeding an
international transaction on the basis of profits tax rates could be a violation of trade in services
rules in the spirit of countervailing action. I suspect that this is a very long shot.
A second is to attempt to mount a grassroots strategy using its rent chain in the U.S. What is the
incentive of insurance agents to take such action? I think their incentive is small, since it depends

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only on the new business that they would obtain if ACE were to cut prices and total revenue were
to increase. In any event, such an effort would be countered by the U.S. insurance companies.
They have a larger rent chain and may better be able to mobilize their rent chain than can ACE.
ACE can also lobby members of Congress and meet with Treasury to discuss the tax advantage.
The question is what message ACE could give. Informational lobbying seems impossible, since
this is a situation of complete information. ACE could also use public advocacy, but there seems to
be little purpose to doing so.
The principal nonmarket strategy thus should be ex ante and would attempt to gauge the likely
nonmarket action of others (and ACEs counter). This is positive analysis and focuses on risk
evaluation.
What is it about this strategy that is integrated? First, the pricing decision has to be made taking
into account the both market considerations and nonmarket effects. Second, the price offered for
Cignas business depends importantly on the assessment of what is likely to happen in the
nonmarket environment. The ex ante (before nonmarket opposition takes place) market and
nonmarket strategies of ACE affects that likelihood. Third, if nonmarket opposition develops, an
ex post nonmarket strategy, and perhaps market strategy, is needed.
Developments
ACE acquired Cignas property-casualty business for $3.45 billion in cash on July 1, 1999. Shortly
thereafter another Bermuda insurance company XL Capital Ltd. acquired Nac Re, a Connecticut
insurance company. Subsequent to these acquisitions four small U.S. insurance companies
announced plan to move their headquarters to Bermuda. The companies were Everest Reinsurance
Holdings, PX Re, Trenwick Group, and White Mountain Insurance Group.
Four large U.S. insurance companies, Chubb, Hartford, Kemper, and Liberty Mutual, went to
Congress to complain about the loss of tax revenue to the U.S. government and the unfair
advantage the Bermuda companies had obtained. The companies went to the House Ways and
Means Committee and the Senate Finance Committee, which have jurisdiction over tax matters.
The Treasury Department was necessarily concerned and estimated a potential loss in tax revenue
of $7 billion a year. The four insurance companies and their congressional allies could easily frame
the issue as tax evasion or tax abuse.
In April 2000 Representative Nancy Johnson (R-CN) introduced H.R. 4192 to amend the Internal
Revenue Code of 1986 to prevent the use of reinsurance with foreign persons to enable domestic
nonlife insurance companies to evade United States income taxation.
ACE called the bill a blatant singling out of Bermuda insurers, veiled as a tax equity issue, despite
the fact that many countries offer lower effective tax rates on insurers than the US. Paul Girdano
of XL Capital said, The effort by a few U.S. insurers to subject their competitors to new taxes is
simple protectionism. US insurers are taxed the same on identical transactions without regard to

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US or foreign ownership because the transactions have the same effect on the US insurers tax
base.25
X.L. Capital was criticized in the press because the reported revenue from the U.S. subsidiary it had
purchased decreased by 82 percent. X.L. Capitals general counsel, Paul Girdano, said the numbers
were being distorted by critics. He said, This is a protectionist effort by four American companies.
Were just arguing to continue to have the ability to run our business by complying with the laws
that are on the books today.26
Should other U.S. companies free ride? Are the own incentives of the four who participated
sufficient to overcome the free-rider problem?
Legislation was pending in Congress to close certain tax shelters, but the legislation the Clinton
administration planned to introduce in its lame duck year was unlikely to progress far in Congress.
The new administration, however, could well take up the cause.
By November 2000 the number of insurance companies moving to Bermuda had increased.
Members of Congress and the Department of Treasury had become increasingly concerned, and
Congress was poised to act. It, however, was late in the term and members were reluctant to act
without a complete recommendation from Treasury on exactly how to close the loophole.
Neither Treasury nor Congress acted on the tax haven issue in 2001, but in 2002 both began to
address the issue. In the interim more U.S. corporations had moved to Bermuda and tax avoidance
was becoming a more visible issue. In effect, the entire U.S. reinsurance industry had moved to
Bermuda. In addition, to the insurance companies a number of manufacturing companies had
relocated there, including two companies found to be in financial difficulty in the wake of the
Enron collapse. Global Crossing, which collapsed and filed for bankruptcy, was located in
Bermuda, and Tyco International, which was found to have accounting problems, was located there.
Other companies that planned to move to Bermuda were Ingersoll-Rand and Stanley Works, a
manufacturer of tools. Others included Accenture, Foster Wheeler, Nabors Industries, and Cooper
Industries. Stanley reported that it saved $30 million annually by locating in Bermuda, and Tyco
claimed it saved $400 million a year. Ingersoll-Rand revealed that it did not even have an office in
Bermuda, and said, We pay a service organization to pick up its mail.27 In 2000 some 12,567
international corporations were registered in Bermuda. Stanleys move required approval by twothirds of its shareholders, and in May it held a vote in which the move was barely adopted. The
Connecticut attorney general filed a lawsuit challenging the vote, and Stanley withdrew the result
and pledged to hold a new election. Stanley planned to incorporate in Bermuda and register as a
resident in Barbados, where it would have to hold only one meeting a year to qualify as centrally
managed and controlled from Barbados.28 Tax experts believed that Stanley could save
substantially more than $30 million.
There are a variety of tax avoidance measures involving offshore tax havens. One enables U.S.
companies to avoid taxes on profits earned on business outside the United States. Enron was found
25

Reinsurance Magazine, May 1, 2000.


The New York Times, March 6, 2000.
27
The New York Times, February 18, 2002.
28
The New York Times, May 9, 2002.
26

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to have 700 subsidiaries registered in the Cayman Islands and 8 in Bermuda. Another allows U.S.
companies to avoid taxes on profits earned in the United States. Since Bermuda does not have a
tax treaty with the United States, this involves using a third country that has a tax treaty with the
United States. Countries such as Barbados and Luxembourg are frequently used. This involves
establishing a paper company in the third country and transferring funds to it, allowing them to be
deducted from taxes. According to one tax attorney, taxes on U.S. profits can be reduced to as little
as 11 percent. (The U.S. corporate tax rate is 35 percent, and on average U.S. corporations paid
21.5 percent in 1998.)
It is important to distinguish between tax avoidance, which is legal, and tax evasion, which is
illegal. Where the line between the two is located is not clear. In a Senate hearing on Enron,
Senator John F. Kerry (D-MA) stated, Theres a fine line between tax avoidance and tax evasion.
Senator Charles Grassley (R-IA), the ranking Republican on the Finance Committee, stated during
the March hearings, From what I have seen, these deals look like shams. I have also heard there
may be an effort to rush these deals to market before Congress cracks down on them. Let me be
clear to everyone developing or contemplating one of these deals: You proceed at your peril.
During the hearing Senator Grassley held up a Stanley saw and said, I hope people will remember
this when they shop for the products this company makes. Their heart doesnt seem to be in
America
The Treasury was planning to prepare a report on tax havens, but an official stated that the problem
may be as much with U.S. tax laws as it is offshore tax havens. Some commentators viewed the tax
havens as improving the competitiveness of U.S. business.
Whether legislation would be enacted to address these means of tax avoidance was unclear.

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Chapter 8
Implementing Political Strategies
This chapter addresses the implementation of political strategies, focusing on the types of activities
firms engage in. Lobbying is the most important activity in informational strategies, and the text
addresses its nature, what makes it effective, what enables it, and the regulation of lobbying.
Whereas lobbying in an informational or representational strategy is typically done behind the
scenes, grassroots campaigns are highly visible and orchestrated efforts to provide information but
more importantly to apply pressure on government officials. How effective these campaigns are is
unclear, but what is clear is that firms have increased their use of grassroots campaigns in recent
years. Grassroots strategies are most effective when they are tied to the constituency connection.
Coalition building is an important part of many representational strategies and is intended to
leverage the political action of a firm. Coalition formation is a component of the CAFE Standards
chapter case.
Testimony is often a component of a political strategy directed toward a legislature or a regulatory
agency. The Breyer reference provides useful insight into the congressional side of a hearing.
The treatment of electoral strategies highlights aspects of the debate on the importance of campaign
contributions, not from the perspective of candidates in elections but from the perspective of the
contributor. This is a topic that may be of more interest to students than to firms, so information is
provided about the market for contributions and the laws governing those contributions.
Communications and public advocacy strategies can be useful in representational strategies, but the
most important communication in informational strategies probably takes place in the context of
lobbying. Advisory committees are important sources of information particularly in countries such
as Japan as discussed in more detail in Chapter 14. From time to time a firm may have to resort to
the courts to deal with an issue, but judicial strategies can be both costly and time consuming and
the outcome uncertain. A lecture might develop further the issue of organizing for political
effectiveness. An example presented here, Soft Cookie Politics, can be used as an illustration for
a lecture.
The framing of an issue may be important to the extent that the issue can be strategically
characterized. For example, in response to the abuse by tax-exempt entities of the leasing
provisions of the Economic Recovery Tax Act of 1981 discussed in Chapter 6, Representative J.J.
Pickle (D-TX) and his staff coined the slogan, Those who dont pay taxes shouldnt get tax
breaks. With the coining of this slogan, the tax benefits to U.S. exporters that used leasing for
their exports were imperiled.
Pharmaceutical Industry Politics: As an addendum to the example of the pharmaceutical
industry and the generic drug issue, the PMA did not quit the battle even after the bill had been
signed by President Reagan. The industry sought a strengthening of patent protection for
manufacturing processes against violations by foreign firms. Under existing law, the patent holder
could challenge infringement only under U.S. trade laws which require a finding of substantial

149

injury by the International Trade Commission. (See Chapter 17.) The legislation sought by the
PMA would make it easier for patent holders to sue domestic firms for patent infringement by their
foreign suppliers. The GPIA asserted that this would allow U.S. drug companies to sue the
European drug companies that supply the chemicals that generic drug companies use to produce
their drugs. What Congress has done is give us something with one hand and take it away with
another, said William Haddad, director of the Generic Pharmaceutical Industry Association.29
Example: Soft Cookie Politics
An example of the use of a judicial strategy is provided by the soft cookie war. Proctor &
Gamble received a patent on a process for making cookies that are crisp on the outside and soft on
the inside, and the cookie was very successful in its test market. Shortly after its introduction
nationwide, Keebler, Nabisco, and Frito-Lay also introduced soft cookies. P&Gs market share
plummeted.
In June 1984, P&G sued its three rivals, charging them with infringing its patent. P&G also sued
them for unfair competition. P&G alleged that in March 1984, a Frito-Lay employee posed as a
customer and attended a confidential sales meeting and that Keebler had taken pictures from an
airplane of a P&G plant under construction.30 In August, Frito-Lay filed counterclaims alleging that
P&G was attempting to eliminate competition in the soft cookie market. Keebler and Nabisco also
filed counterclaims.
Frito-Lay denied P&Gs allegations that one of its employees had improperly attended a P&G sales
meeting and that it had obtained information improperly on P&Gs patented production process.
According to Frito-Lay, one of its employees and his son were outside a baking facility
where P&Gs Duncan Hines cookies were being made. Someone at Frito-Lay had
authorized the employee to take photos outside.
Without the companys authorization or knowledge, the son twice walked into the plant
during working hours, the company said. The son asked for and was given two unbaked
cookie samples, which were believed to be Duncan Hines.
When the samples and photos were taken to Frito-Lay headquarters in Dallas, a vice
president immediately had them destroyed, Frito-Lay said.
With respect to the sales meeting, Frito-Lay stated, While a Frito-Lay employee was engaged in a
sales call to a customer, a P&G sales representative joined them and made an unsolicited sales
presentation to the customer in the Frito-Lay employees presence.31
After pretrial activities extending over 872 days, involving over 200 expert witnesses, and
producing over 100,000 pages of pretrial testimony, in September 1989, three weeks before trial
was set to begin, the litigants entered into a consent decree in which P&G received over $125
The Wall Street Journal, October 2, 1984.
The Wall Street Journal, September 11, 1989.
31
The Wall Street Journal, August 27, 1984.
29
30

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million from the three defendants.32 Frito-Lay stated that it would pay less than $20 million and
that insurance would cover the payment.

Cases
Drexel Burnham Lambert and Junk Bond Politics
Drexel faces a complex set of issues stemming largely from its highly successful strategy of
financing hostile takeovers, leveraged buyouts, and other corporate restructurings with high-yield
(junk) bonds. These issues are both immediate and longer-term. It faces the immediate problem of
stopping the rash of bills in Congress and the longer-run problem of preventing what are likely to
be recurring threats to its junk bond business. This issue subsequently was overwhelmed by the
insider trading issue, but the case should focus on the legislation described in the case. It should be
emphasized that part of the concern of some members of Congress is due to the evolving savings
and loan crisis. Many S&Ls bought junk bonds in an attempt to earn enough to regain solvency.
This is an issue of interest group politics, although politicians are interested in it because they
believe their constituents may be interested. It largely pits parts of corporate America concerned
about hostile takeovers against the underwriters of junk bonds. Drexels basic strategy is to attempt
to stop the legislative threats now by expanding and complexifying the issue and by transforming
the politics of the issue from interest group politics to majoritarian politics. The interests concerned
about the junk bond issue include corporations that might be the subject of a hostile takeover and
organized labor that fears that restructurings will threaten the rents of union members. The AFLCIO opposes the use of junk bonds in takeovers because it fears that inefficient units will be shut
down. Also concerned are those who benefit from restructurings financed by junk bonds, including
a number of high-growth firms.
Drexel has an opportunity to act as a political entrepreneur by bringing into the political
competition those who benefit from the use of junk bonds. The beneficiaries of high-yield bonds
are their issuers and their stakeholders. The difficulty in using them in a political strategy is that
one-time issuers have little incentive to participate politically on the issue and those who will use
them for the first time in the future are largely unidentified and cannot be expected to take political
action. Those who might take political action are issuers that anticipate having a continuing need
for financing and do not anticipate being able to issue investment grade bonds in the near term.
These are the firms that Aylward has proposed to organize, and Drexel should (which it did)
embrace his proposal.
It is important to note that the leading investment banks will not join with Drexel in a coalition.
Furthermore, because of their corporate clients who fear a hostile takeover, many will not oppose
the legislation directed specifically at junk bonds. Drexel can expect little support from the
investment banking community. Many, if not most, investment banking firms are opposed to
Drexels strategy and practices and are suspicious of it and its success. (Some of it might be
jealousy.) The amount of support depends on the issue. The following table summarizes the extent
32

The New York Times, September 13, 1989.

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to which other firms will be aligned with Drexel on various issues as cataloged by how the junk
bonds are used.

Junk bond used for


hostile takeovers
restructuring
control transactions
mergers and friendly acquisitions
holdings by S&Ls

Aligned with Drexel


investment banks
businesses
none
few
a couple
modest number
a couple
modest number
all
most
few
S&Ls in trouble

Note that there are few investment banks relying on junk bonds, and most large businesses oppose
their use, often because they are used in hostile takeovers. Also, note that the concern about S&Ls
holding junk bonds that might default applies to all junk bond issuers.
From the perspective of the theories of Chapter 5, this is a multidimensional issue in which there
probably is no majority winner. Drexel wants to maintain the status quo and as a basic strategy
wants to complicate the issue by stressing its complexity and emphasizing the uncertain
consequences of the actions being contemplated by Congress. Drexel thus wants to emphasize the
multiple dimensions of the issue and the range of possible harmful consequences of the various
bills. The idea is to emphasize uncertainty and complexity with the hope that that will make it
difficult for Congress to act, thus preserving the status quo.
Drexels overall strategy can be built on the constituent connection and directed toward
complexifying the issue. One component of its strategy is informational to present facts that
will counter the facts and claims by the opponents of junk bonds. The implementation of this
strategy has several components. One is lobbying directed at informing members of Congress and
other policy makers that junk bond financing is beneficial to the economy. (As indicated below,
this is an easy message to convey.) A second component involves the use of Aylwards
organization as part of a representational strategy. A third component is electoral and involves
campaign and other contributions to members of Congress.
Information provision through lobbying should be directed to the members of the relevant
committees and their staffs followed by lobbying other influential members. Lobbying should also
be directed to the executive branch including the Departments of Commerce and Treasury, the
Executive Office of the President, the SEC, and the FSLIC. The objective of this lobbying should
be to have them study and with luck oppose the legislation. Since restrictions on the use of junk
bonds are likely to impede market efficiency, executive branch agencies are not likely to support
the legislation. Whether they will oppose it is not clear. The lobbying can be done by Drexel
executives, its clients, and Aylwards organization. This is then a variant of a grassroots strategy.
The principal message to convey in the lobbying is that junk bonds are essential to growth, jobs,
and competitiveness. The most important specific information to provide is that most
congressional districts do not have firms that can issue investment grade securities. In the entire

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United States there were only 600 companies with investment grade securities, and there are 22,000
firms with sales of at least $25 million that were not of investment grade. Drexel can easily
determine the number of states and districts that have no investment grade firms (and the number of
employees they have) and use that as its basic message. A dozen states have no investment grade
firms. Another lobbying strategy is to inform members of Congress about firms in their district that
have issued high-yield bonds to finance their expansion. For example, 32 firms in Virginia
employing 64,000 people had used these bonds.
One impediment to Drexels lobbying strategy was that it had not previously invested in
relationships and access in Washington. Drexel thus needed to obtain access and obtain it quickly.
Some of the steps taken by Drexel are indicated below.
Drexel also needs to provide information to the media and opinion leaders. Op ed pieces such as
that by Fred Joseph were one element of that strategy. It might be possible to educate the business
writers of major publications so that their stories will be more accurate and balanced. The
difficulty for Drexel is that the general media is covering junk bond issues, since it is currently
newsworthy. The general media can be expected to focus on emotional dimensions of the use of
junk bonds such as cases in which the jobs of employees of targets of hostile takeovers or LBOs are
threatened.
Another element of a political strategy is advocacy advertising directed at Washington policy
makers.
Drexel executives will surely be asked to testify before congressional committees. The messages in
that testimony should be the same as in its lobbying. The hearings themselves could well be shows
rather than informational sessions, since some members of Congress will see this issue as an
opportunity to get air time.
Given the complexity of the issues and the difficulty Congress will have in writing legislation that
allows junk bonds to be issued for growth purposes but not for purposes such as hostile takeovers,
Drexel has a good chance of avoiding legislative restrictions. Issues associated with junk bonds,
however, were likely to continue to be important, and hence Drexels efforts on these issues provide
a basis for a longer-term strategy.
Another dimension of this issue that the case does not address is the possibility that the regulatory
agencies with jurisdictions over financial institutions will restrict the latitude of institutions to hold
the bonds.
Teaching the case:
The opening question might be, What are the lightning rods here? or What are the issues Drexel
faces? The lightning rods are hostile takeovers and greenmail, the financial problems of S&Ls,
the high fees earned in control transactions, and claims about the diversion of capital (largely a red
herring).

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The next question might pertain to the interests concerned with this issue and who has interests
aligned with Drexels. This analysis could be summarized in a distributive politics spreadsheet.
The remaining questions might focus on the overall strategy, its components, and its
implementation. A potential distraction in the discussion of the cases is that the junk bond issue
became complicated by the insider trading issue that eventually brought down Michael Milken and
Drexel. At the time of the case, the insider trading issue had not arisen.
An important issue to be pursued in the case is the limits of responsible political action. One way
to approach this issue is to describe some of Drexels actions and to ask if they are responsible.
Drexel conducted an intense and expensive political campaign employing many of the strategies
discussed in the text. The campaign bordered on the excessive.
Another question that might be asked is whether Drexel should participate in fewer hostile
takeovers. That is, should it adjust its market strategy?
Drexels actions and the outcome:
Political entrepreneurs are sometimes found in the ranks of former government officials who
recognize a demand for political action and see an opportunity to undertake political activity in
support of some political objective. Recognizing the nature of the politics of the junk bond issue
and realizing that the issue would spread to junk bonds used to finance young, growth firms that
had not yet attained an investment-grade bond rating, David Aylward proposed to Drexel that he
form a coalition of firms that financed their expansion through high yield bonds. He presented to
Drexel an integrated political strategy for influencing Congress in its deliberation on junk bond
issues. The proposal was accepted, and Aylward formed the Alliance for Capital Access, which
included among its members Calvin Klein, Kinder-Care Learning Centers, Lorimar, Southmark,
and Wickes. The Alliance undertook lobbying, coalition building, and educational activities in
addition to testifying before Congress. The stages of the strategy Aylward proposed were first to
identify the targets and dangers from these issues. This was followed by an educational campaign.
The next stage was to develop a network of companies that would participate in the implementation
of its political strategy. The following stages were to educate key Washington officials, then to
educate the public and opinion leaders more generally, and to activate grassroots pressure.
Prior to 1985, Drexel had no presence in Washington. When the concern about junk bond financing
of hostile takeovers mushroomed and congressional activity intensified, Drexel realized that it
needed to develop a political capability. With ample resources, Drexel opened a Washington office
and hired a formed White House aide Mary Jo Jacobi to head it. It also hired two professional
lobbyists including Robert Strauss, the former head of the Democratic Partys National
Committee. Its PAC increased contributions by nine fold to nearly $180,000, and Drexel also
encouraged its clients to make contributions. Drexel made hundreds of thousands of dollars of soft
money contributions to members of Congress. Drexel also invited members of Congress to speak
at Drexel conferences and paid them fees. Part of the discussion might focus on whether these
activities were responsible.

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Drexel also undertook a public advocacy program intended to educate the public, opinion leaders,
and members of the Congress about the benefits from junk bond financing and to improve its
tarnished public image. In one television advertisement, the scene is a dusty vacant lot with a sign
plant site but no construction underway. The commentator states that the plant was not built
because of a lack of capital.
In a television ad campaign in 1987, one ad stated In 1983, over 16% of the population of Vidalia,
Louisiana, were unemployed.In December 1986, the Catalyst Energy Corporation began
construction on the Vidalia, Louisiana, hydroelectric plant, financed with the help of high-yield
bonds provided by Drexel Burnham. Today, this project has helped reduce unemployment by over
20% proof that high-yield bonds are not just good for business, but for everyone.33
Another ad extolled how California schoolchildren could play on playgrounds that had been closed
because of the inability of school districts to obtain liability insurance. The ad reported how Drexel
had underwritten municipal bonds for the school district that enabled it to reopen its playgrounds.
Both of these advertisements were shot in Fort Smith, Arkansas. Drexel was estimated to have
spent $4 million on its two television advertisements and more on its half-dozen newspaper ads.
Fred Joseph defended the ad campaign by stating, We think its useful for everyone to understand
that were not all yuppies shuffling paper here on Wall Street. We want people to understand that
these bonds create employment and cheap electricity and do things that are beneficial.34
After the stock market crash on October 19, 1987, Drexel continued to emphasize its theme of
providing small and growing firms access to capital. In a full page advertisement in The Wall
Street Journal, it stated that it had not stopped aiding firms in raising capital through issuing highyield bonds. It reported that it had underwritten $6.444 billion of high yield bonds from October
19, 1987 through April 4, 1988, which was 54.3% of the total issued. In the first half of 1988,
Drexel received $161.2 million in underwriting fees, up from $130.8 million in the first half of
1987.
Drexels lobbying intensified in 1988, but it did not prevent congressional investigations into
Michael Milkens activities. Representative Dingell went ahead with hearings in which Mr. Milken
took the Fifth Amendment.
None of the bills was passed by Congress. The insider trading scandal brought down Michael
Milken and wiped out Drexel.

33
34

The Wall Street Journal, December 8, 1987.


The Wall Street Journal, December 8, 1987.

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CAFE Standards
Transparencies are available for this case cafeslides.ppt.
This case takes place at the beginning of the 1990s, and in addition to focusing on the case itself,
the discussion can turn to the situation at the beginning of the 21st century, The issues are much the
same, but the scientific evidence on global warming is more conclusive although there remains
considerable uncertainty about the magnitude and the effects of global warming. The other major
development is that the demand for light trucks and SUVs, which have much lower fuel economy
standards than passenger cars, has grown dramatically and now represents more than half the light
vehicle market. Activists have argued for higher fuel economy standards for both cars and light
trucks, and if the United States is to meet the targets of the Kyoto Protocol, attention will have to be
given to light vehicles.
This is a relatively complex case that involves interest group competition, the formulation of
political strategies, and the implementation of those strategies. It also provides a good vehicle for a
term paper assignment or for group presentations along the lines indicated at the end of the case.
The case can also be used as a basis for oral reports by groups assigned to the roles of Ford and
Nissan. This can be supplemented by assigning other groups to the role of environmentalists.
Many students read this case and think that this bill will surely pass because higher fuel efficiency
surely must be good. This view may also be due to a belief that the global warming problem is
imminent and serious. Whether global warming is actually occurring is not clear at the time of the
case, and whether increased fuel economy is good public policy is not clear. It is easy to say that
higher fuel efficiency is good, but the issue is that it is not free. Moreover, it is clear that
consumers prefer larger and less fuel-efficient vehicles. The costs of higher fuel efficiency
generated the opposition to higher standards. The public interest in this case is thus to be
discovered. It is also important to remind students that even though the 1990 fleet averages had
declined from earlier levels, the average fuel economy of the stock of automobiles in use continued
to increase because older, less fuel-efficient vehicles are being replaced by more fuel-efficient
vehicles.
Some students may argue that higher fuel efficiency is good because it would reduce the demand
for oil and would reduce the U.S. trade deficit. This might be true, but higher fuel efficiency
standards are a bad means of reducing dependence on foreign oil. The best means would be a tax
on crude oil or on refined petroleum products. In reality U.S. oil consumption has steadily declined
until the end of the 1990s, and this has not been an issue.
Such a tax would be the best means of achieving lower total gasoline consumption, which is the
objective of fuel economy standards. An Arthur D. Little study showed that the cost of gasoline per
mile driven had fallen from 12 cents in 1981 to 5 cents in 1990. A tax would be the most efficient
means of reducing total consumption. (Increasing taxes is hard to do in the current political climate,
however, as President Clinton learned in 1993.)
The point of this case is not to argue the public policy issues but to consider the issue from the
point of view of the managers of auto companies. Managers must analyze the politics of the CAFE

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standards issue, identify objectives, formulate a strategy for increasing the likelihood that those
objectives will be achieved, and develop a plan for implementing that strategy.
Transparencies present the nonmarket issue life cycle and the four Is for the CAFE standards issue.
The specific issues center on Senator Bryans bill. The bill and the broader issues have the
following dimensions: 1) the amount of the increase, 2) whether the increase will be specified as an
absolute amount or a percentage from a base, 3) the year on which a standard would be based under
a percentage increase standard, 4) the rate of increase, 5) the discretion to be granted to DOT to set
interim standards, 6) a possible antibacksliding provision, 7) a model-based standard system (to
prevent backsliding) versus a corporate average system, 8) limits on outsourcing, and 9) whether
lift trucks will continue to be covered under a separate system.
The U.S. auto industry is threatened by this bill, but the percentage basis provides it some
consolation. Some students might claim that U.S. auto companies should support the bill because
although it will force them to make major changes in their automobiles it will give them an
advantage relative to their Japanese competitors. This claim is probably untrue because of the
severity of the increase. Certainly, the U.S. auto companies did not see it as an advantage. The case
should be discussed under the assumption that U.S. auto companies and the UAW will be hurt
badly by the Bryan bill but would be hurt worse if the percentage system were not used.
This is an issue of distributive politics pitting environmentalists and certain other activists against
the automobile industry. The UAW often sides with the environmentalists, but in this case its
interest are aligned with the auto companies and it will oppose the bill, at least in its lobbying if not
in its public rhetoric. The other interests affected include consumers, who will face higher-priced
and smaller autos and will have less choice. Everyone is affected by global warming and other
environmental consequences. The benefits thus are widely distributed among those who might be
harmed by global warming, and the costs are concentrated on auto companies, their suppliers, and
the UAW. The basic politics of this issue thus are entrepreneurial with environmental activists and
Senator Bryan acting as the entrepreneurs.
The percentage approach issue (conditional on the standards being increased) is basically interest
group politics pitting the Japanese auto companies against the U.S. auto companies and the UAW.
Environmental activists also will support the percentage approach but might be just as happy with
an antibacksliding provision. Their support for the percentage approach will be muted. On an
issue such as a prohibition of outsourcing, the politics are interest group with auto companies
opposing the UAW and probably the environmental activists who might support their labor allies on
this issue.
The objectives of the auto companies are presented in the transparencies. The alignment of
interests depends on which dimension of the bill is in question, and the basic strategy is presented
in the transparencies.
The relevant institution is Congress, but the executive branch will also be involved. The
Department of Transportation will play a role, and President Bush can be expected to veto any bill
that would severely harm the economy.

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The immediate focus of the auto companies is the defeat of the Bryan bill in the Senate followed by
developing opposition to it in the House. In part, the latter involves supporting Representative
Dingell in his efforts to stop any major increase in the CAFE standard.
The basic strategy of the U.S. auto companies is to generate political pressure by highlighting the
costs that a higher CAFE standard would impose and by complicating the issue by supporting
alternatives such as a carbon tax. Pressure can be generated through lobbying and grassroots
strategies. Public advocacy and testimony can be used to put alternatives on the public agenda.
Lobbying, grassroots strategies, testimony, and public advocacy can be used to highlight the costs
of the bill. Campaign contributions can be used to gain access and perhaps influence.
The basic strategy of foreign auto companies is similar, but their strategies are also directed toward
deleting the percentage approach. The approach of the Japanese auto companies should be to apply
pressure and argue that the percentage approach constitutes an unfair trade practice. As a last
resort, the Japanese auto companies should also propose that an antibacksliding provision be
substituted for the percentage approach, since that will hurt them less and will meet some of the
concerns of the environmentalists.
One issue for discussion is whether a coalition of U.S. and Japanese auto companies can be formed
on this issue. This seems possible since they can both agree on the objective of defeating the Bryan
bill.
One component of the strategy of the auto companies is to propose alternative means of improving
the fuel economy of the U.S. fleet. The first thing to note is that CAFE standards pertain only to
new autos. One means of improving fuel economy is to eliminate old fuel-inefficient autos. In
1991, the consulting firm DRI/McGraw-Hill proposed that the government purchase and scrap 9
million 1967-1978 autos by offering a bounty of $700 per auto. (In Chapter 18, a voluntary policy
of ARCO that provided the idea for this proposal is discussed.) Not only do these autos get poor
gas mileage but they do not have catalytic converters and thus have high emissions of pollutants.
Eliminating them would both reduce emissions and improve fuel economy as scrapped autos are
replaced with new autos. For the auto industry, this proposal also has the advantage of generating
demand for new autos. DRI/McGraw-Hill proposed that this program be financed by a 2-cents-pergallon gasoline tax. The consultants study was financed by ARCO, Chevron, and Texaco.
Another strategy for opposing higher standards is to generate grassroots pressure on Congress. But
who would be willing to oppose higher CAFE standards and why would they oppose it? One
consequence of higher CAFE standards is that they would lead to smaller autos. Consequently, one
possible source of grassroots opposition is those people who prefer large autos. Who are these
people? One group is the elderly who have difficulty getting in and out of small cars. Another
group is the disabled who also may have difficulty getting in and out of small cars. The industry
was successful in generating opposition to the bill by groups representing the elderly and
handicapped. Another theme to emphasize is that smaller cars are inherently less safe for their
occupants than are larger ones.
A group called Coalition for Vehicle Choice (CVC) also was formed to oppose higher fuel economy
standards. The Coalition was composed of more that 200 Automotive and Other Business,

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Consumer, Farm and Safety Organizations. Its advertisement in the Washington Post was
headlined WHO SHOULD CHOOSE YOUR NEXT CAR? YOU OR CONGRESS and began If
the Bryan bill or other legislation requiring dramatically higher Corporate Average Fuel Economy
(CAFE) standards is successful, the federal government in Washington will decide what you can
buy. The ad concludes with If you want to make your own decisions, decide against higher
CAFE standards and against the Bryan bill.
A CVC television advertisement shows a 2,300 pound car being demolished by a 4,000 pound car.
The industry put more than $10 million into the Coalition.
As its head, the Coalition hired Diane Steed who was administrator of NHTSA in the Reagan
administration. One of her most vocal opponents has been Joan Claybrook, also a former NHTSA
administrator, who headed the Nader organization Public Citizen. Clarence Ditlow of the Center
for Auto Safety said, CVC is another industry front organization, but on a grander scale.35 The
Energy Conservation Coalition, formed with the support of twenty environmental and consumer
interest groups, also attempted to counter the CVCs activities. A dissident group of union
members which formed UAW New Directions also opposed the CVCs activities.
Another means of generating opposition for higher CAFE standards is to mobilize grassroots
opposition. The auto industry hired a Washington political consulting firm to generate a grassroots
campaign. The firm organized groups such as Nevadans for Fair Fuel Economy Standards,
which generated over 10,000 letters to Senator Bryan opposing his bill and West Virginians for
Fair Fuel Economy Standards, which flooded Senator Jay Rockefeller with letters.
One opportunity for analysis in this case is to study the preferences of the members of the
Commerce Committees of Congress. The ratings of members by League of Conservation Voters
and the Chamber of Commerce can be used as rough indicators of the preferences of members of
the committees for environmental Protection and business, respectively. (See Barone and Ujifusa
(1998) for interest group ratings of members of Congress.) Those members who are in the middle
represent important targets for lobbying. As part of their lobbying, the chairmen of Chrysler, Ford,
and General Motors wrote to senators explaining why the bill should not be passed. The auto
industry has also made substantial campaign contribution to members of Congress, spending $20
million over the past six years.36
The UAWs basic substitute for defeat of an increase in CAFE standards is to prevent outsourcing.
It seems unlikely that the UAW has the support for separate legislation to limit outsourcing, and
such a bill would surely be vetoed by President Bush. The UAW might, however, be able to strike
a deal with the proponents of the increase in CAFE standards in which the UAW supports the
increase in exchange for a provision that limits outsourcing. The UAW would also prefer the
percentage approach, and the environmentalists should support that. Although this is an imperfect
substitute for the UAW, it represents an alternative that poses a considerable risk to auto
manufacturers. The auto companies will have to work simultaneously to defeat the CAFE increase
and keep the UAW on board.
35

The Wall Street Journal, September 20, 1991.


In 1988, the Auto Dealers and Drivers for Free Trade, which primarily represents imported auto dealers, contributed
over $500,000 to incumbent Republican Senator Chic Hecht of Nevada in his unsuccessful attempt to retain his seat
against Democratic challenger Richard Bryan.
36

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Another risk to the auto manufacturers is President Bushs energy plan, which was scheduled to be
announced at the beginning of 1991. The Department of Energy (DOE) was preparing a broadscale
program for reducing energy use, but there was strong opposition to the program by others in the
Bush administration. The Council of Economic Advisors was opposed to much of the initial plan
and particularly to the initial proposal to support higher CAFE standards. DOE dropped its support
for higher CAFE standards.
One aspect of the political strategy adopted by the auto industry is described in the following
excerpt from a Fortune, December 3, 1990 article (pp. 75, 76, 80, 84) on the strategy formulated by
Mark Bonner, who ran a Washington-based lobbying firm.
The automakers knew that pushing even a mildly sophisticated cost-benefit analysis would
sound like an argument for dirty air. They aimed instead to sell a simpler message: The
extreme environmental position would endanger big cars. So they built support among
employees and suppliers, and then enlisted Bonner to find other allies.
He first analyzed which groups would lose most if Detroit stopped making big cars, and
then urged them to call or write their senators. Among those who wrote Washington
passionately were old people and the handicapped, who have trouble getting in and out of
small cars and worry about safety. Volunteer groups that ferry members around, such as
Big Brothers/Big Sisters and the Boy Scouts, also lent support. So did policemen, who like
their cruisers big and fast. The president of a Nebraska farm bureau, an Alabama sheriff,
and the head of a Florida senior citizen organization were among the star witnesses flown
by Bonner to the capital for a press conference. Industry lobbyists say these efforts
helped. (p. 80)
Teaching the case:
One way to begin the case is to present the nonmarket issue life cycle of the fuel economy issue as
presented in the transparencies. The issue was identified in the aftermath of the 1973 war in the
Middle East when the United States experienced gasoline shortages and sought to reduce its
dependence on unreliable supplies of foreign oil. The United States was criticized for consuming
such a high percent of the worlds oil production. Interest group activity began around concerns for
national security (from dependence on uncertain supplies of foreign oil) and developing concern for
energy conservation. The issue moved quickly to the legislative stage, and the Energy Policy and
Conservation Act of 1975 established a goal of increasing average fuel economy from 14 miles per
gallon to 28 miles per gallon. The administrative phase involved delegation to DOT to administer
the fuel economy program. Enforcement included the gas guzzler tax and penalties for not
achieving the standards. The fuel economy issue entered a second phase as a result of the
emergence of the global warming issue and when consumers began purchasing larger automobiles.
The case can be taught by asking a series of questions.
1. What are the likely consequences if S. 1224 is passed? What are the consequences of the
percentage approach
2. What is the nature of the politics of the issue?

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3. Which interests are affected and which interests can be expected to be active on this issue?
4. What objectives should an auto company select? How likely is it that those objectives can be
achieved?
5. What strategy should an auto company adopt?
6. How should that strategy be implemented?
7. What strategy will the environmentalists employ?
8. How likely is it that the auto industry will be able to defeat this bill?
9. Which legislators hold strategic positions in the congressional process through which the bill
must pass?
Outcome:
In August 1990, Iraq invaded Kuwait and oil prices jumped. This put pressure or senators who were
scheduled to vote on the Bryan bill in September. Opponents of the bill, however, continued in their
plans to filibuster when the bill was considered on the floor. Floor consideration began on
September 14 and a cloture motion was made immediately and it passed 68 to 28.
The Insurance Institute for Highway Safety countered with a study of the death rates for 11 GM
models which had been downsized and found that the rates were significantly higher than for the
earlier versions. It also reported that in 1979 Toyotas and Nissans had a 56% higher death rate
than Ford and GM cars but that the difference in death rates had narrowed substantially. DOT
estimated that downsizing autos since 1979 had resulted in 1,340 deaths in single-vehicle rollover
accidents. A study conducted by researchers from the Brookings Institution and Harvard University
concluded that deaths would increase by 3,900 over the next ten years for just the 1989 models.
The Insurance Institute found that the smallest cars had death rate ratio of 3 to 1.3 for the largest
cars. Ralph Nader stated that the safety concerns raised about higher CAFE standards are totally
untrue and bogus.
The Bush administration was also ready and pulled out all the stops. Immediately after the vote,
Secretary of Transportation Samuel Skinner held a news conference calling the goal in the Bryan
bill completely unrealistic. He released a safety study and said the bill should really be named
the Highway Fatality Bill.37 Secretary Skinner stated that 1,340 additional people a year would die
because of the bill. The head of the NHTSA corrected the Secretary, stating that the Bryan bill
would reduce car weight by 450 to 850 pounds which would increase fatalities by 611 to 1,149 and
injuries by 2,900 to 5,350, based on the current fatality rate.
William Reilly, head of the EPA, joined in by stating that the Bryan bill would actually increase air
pollution. The EPA also released a study showing that 9 of 10 of the most fuel-efficient 1990
models are made in Japan. Skinner, Reilly, and Energy Secretary James Watkins sent a joint letter
to senators asking them to reject the Bryan bill.
Transparencies summarize the implementation of the auto companies strategy. A second vote to
invoke cloture failed 57-42, and the bill died. Eleven senators switched their votes on the second
cloture vote. Eight were Republicans, and three were Democrats. The three Democrats were
pivotal and each had an auto plant or major parts suppliers of Japan auto producers in their state.
37

The New York Times, September 15, 1990.

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This indicates the importance of having all the auto companies on the same side of the issue and
working parallel if not together.
Bryan pledged to reintroduce the bill in the next session. Daniel P. Becker, who heads the energy
and global warming program of the Sierra Club said, Today the gas guzzlers won and theyre
popping the champagne corks in Saddam Husseins palace.38 The fuel economy bill never got out
of committee in the House. The Bryan bill was introduced in the next Congress as well but did not
get close to passage.
After the vote, Business Week, October 8, 1990, reported that U.S. and Japanese auto firms were
joining forces to oppose the Bryan bill in the future.
In December, the Department of Transportation announced that the National Research Council, an
arm of the National Academy of Sciences, would study the mileage-standard issue and provide
recommendations. This signaled that higher mileage standards would not be a part of the Bush
administrations energy plan. In April 1992, the NRC released a study commissioned by the
Department of Transportation. The study concluded that fuel economy of the new car fleet could
be increased to 31-33 miles per gallon by 2001 and to 36 by 2006. Environmentalists criticized the
studys conclusion arguing that the 36 mpg figure could be reached considerably earlier. The auto
industry referred to the report as a total rebuttal of the extreme requirements sought by the
environmentalists. The NRC report did not recommend an increase in fuel economy standards and
also addressed other dimensions of the issue. It estimated that the prices of a new auto would
increase by $500 to $2,500 and that safety would be reduced.
In 1997 NHTSA issued a report concluding that CAFE standards increased deaths by 2,000
annually. The study was an important factor in the success of anti-CAFE forces in blocking efforts
to increase standards. By 2002 environmental concerns over global climate change and security
concerns led to renewed efforts to increase CAFE standards. In 2001 Honda redid NHTSAs 1997
study taking into account advances in safety features such as air bags. Honda concluded that CAFE
standards that would reduce the weight of a car by 100 pounds would have a statistically
insignificant effect on deaths. NHTSA countered by conducting a study of its own using new
methods. The study was expected to be released in Spring 2002.
In Congress Senators Kerry and McCain joined in sponsoring a bill to increase standards from the
current average of 24 for light vehicles including light trucks to 36 mpg by 2015. Opposition by
the auto industry and its allies in Congress was expected to be fierce. Nearly all the auto
companies with the exception of Honda that sell in the United States belonged to the Alliance of
Automobile Manufacturers, which opposed any increase. This bill did not pass.
In 2002 a bill combining light truck standards with automobile standards and significantly
increasing the standard from the current level was pushed in the Senate. Support for higher
standard were spurred by security concerns and a desire to reduce dependence on foreign oil.
Nevertheless, the Senate dropped the provision for higher standards.

38

The New York Times, September 26, 1990.

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A more serious threat to the auto industry occurred in California in 2002. A bill AB1058 introduced
in the state Assembly would direct the Air Resources Board to reduce greenhouse gas emissions
from road vehicles. When the bill was introduced, the auto industry and the major environmental
group paid little attention to the bill, but in the spring of 2002 a majority of the Assembly were
prepared to vote for the bill. The Air Resources Board and the state Department of Energy issued a
report discussing options for achieving the reductions. The options included a tax of up to $3,500
on SUVs, minivans, and light trucks, a $0.50 increase in price of gasoline, and a reduction in the
speed limit. In the initial vote the bill received 42 votes, one more than needed for passage. The
state Senate passed the bill on a 22-13 vote as all the Democrats voted for it.
Belatedly, the auto industry, labor unions, oil companies, and others addressed consumers
concerned about their vehicles. The industry conducted an intense advertising campaign to
generate grassroots opposition to the bill. The ads featured Cal Worthington, a California car dealer
who had become a cult figure. Some ads emphasized the choice issue, Dont give bureaucrats a
blank check to decide what you drive. One assemblyman reported receiving 500 telephone calls
in one month from angry constituents. The California Motor Car Dealers Association weighed in
against the bill. Ray Buttacavoli, a lobbyist for General Motors, said, It really is an attempt to
regulate fuel economy on new motor vehicles; make no bones about it.39
Environmental groups including the Natural Resources Defense Council and the Bluewater
Network countered with an advertising campaign attacking the claims of the industry. The bill was
also supported by some municipal utilities and Silicon Valley investors concerned about a water
shortage.
Several assembly members backed off their support for the bill. Tom Harmon (R-Huntington
Beach) said, Ive had a change of heart on this issue. SUVs and light trucks are very popular in
Southern California, and people dont want to lose the ability to ride these vehicles,
notwithstanding the fact that they are polluters and gas guzzlers.40 Harman was the recipient of
the 500 calls. The bill failed in the Assembly.
Current information on CAFE standards is available on the CVC web site.

Proposition 211: Securities Litigation Referendum (A)


Trial lawyers regularly file class action securities fraud lawsuits when a companys share price falls
significantly, usually by 10% or more. Most lawsuits were filed against high tech companies whose
stock prices were naturally volatile, and the companies viewed these lawsuits as extortionary. This
case deals with an effort by Silicon Valley firms to defeat a state referendum that would make it
easier to win securities fraud lawsuits in state courts. This effort marked the beginning of the
organized nonmarket efforts by Silicon Valley firms.

39
40

Los Angeles Times, May 21, 2002.


Los Angeles Times, May 21, 2002.

163

The Supreme Court decision allowing cases to be tried on the concept of fraud on the market
proved to be a boon to the trial lawyers. Cases could now be brought without any specific
information about fraud or misstatements by management, and lawsuits were generally filed after a
drop of 10% or more in the share price of a company. The objective of the lawsuits was generally
to extract a settlement from companies that knew it was better to settle rather than to go through a
costly and disruptive discovery process and the uncertainty of a trial and a jury decision. Lerach
and other trial lawyers in the business of filing class action lawsuits alleging securities fraud
understood that this was the rational response by management and hence could be confident that
companies would settle. The lawyers thus were in a secure position to extort settlements from
companies and take one-third of the settlement. Moreover, the trial lawyers could attempt to extort
settlements from so-called aiders and abettors. The following Exhibit 1 lists the settlement amounts
received by the Lerach firm alone. Needless to say, companies were furious with a system that
made extortion so easy.
The business response to the actions of the trial lawyers was to seek passage of the PSLRA, which
was one of the planks of the Republicans Contract with America. The PSLRA provided
important safeguards to management while still allowing cases for which there was evidence of
fraud to go forward. The three most important features were the limited safe harbor for forwardlooking statements, heightened pleading standings, and a stay of discovery while a motion to
dismiss was under consideration. In addition, the PSLRA would designate as lead plaintiff the
holders with the largest stake in the issue. This would generally be a mutual fund, which would
then be able to designate its counsel. The Lerach firm and others specializing in these lawsuits
would thus lose considerable business.
The PSLRA was passed overwhelmingly by Congress, but vetoed by President Clinton. Clinton
was beholden to the trial lawyers who were closely aligned with the Democratic Party. The Trial
Lawyers Association, for example, was the largest contributor of campaign funds to the Democratic
Party, and the trial lawyers themselves made large contributions to the Democrats. Bill Lerach and
his firm had made contributions of $465,000 to the Democratic National Committee during the first
half of 1996 alone. Clintons indebtedness to the trial lawyers led him to veto the PSLRA, but his
veto was quickly overridden by Congress. This was the first Clinton veto to be overridden.
The PSLRA, however, pertained only to lawsuits filed in federal courts. The trial lawyers hence
took their cases to state courts under state securities laws. What the backers of the PSLRA should
have sought was to require all such lawsuits to be filed in federal courts, which then would be
governed by the standards in the PSLRA. This in fact was the approach taken in 1998 and 1999 by
business interests in the Uniform National Standards Act which would require securities fraud
lawsuits to be filed in federal courts.
Since many of the companies with volatile stock prices were young, high tech companies and many
of those are located in California, California courts saw a rush of securities fraud cases filed.
Business responded with Propositions 201 and 202, both of which failed to receive a majority.
Proposition 202 in particular would hurt the trial lawyers by capping their fees in cases in addition
to securities fraud cases. Buoyed by their success in defeating Propositions 201 and 202, the trial
lawyers qualified for the ballot Proposition 211. The most incendiary features of Proposition 211
were the removal of the safe harbor provision, allowing punitive damages, elimination of a stay of

164

discovery, and making directors and officers personal assets available to cover damage awards.
The last feature would cause many members of boards of directors and many company officers to
resign. Prop 211 would also allow lawsuits against any company whose shares were held by a
California resident. Although this provision would likely be challenged in court on constitutional
grounds, it had the potential of covering virtually all companies with traded securities covered by
the Securities and Exchange Act.
Initial polls showed strong support for Prop 211, and the trial lawyers used messages that made
Prop 211 appear to be directed at protecting little investors from becoming victims of fraudulent
statements by management. The proponents of Prop 211 were closely aligned with the state
Democratic Party and with their allies the labor unions. In addition, the trial lawyers sought
support from the elderly who could be made nervous by the thought that their savings could be lost
through fraudulent statements by management. The trial lawyers used images of Charles Keating
and the Orange County bankruptcy to raise concerns among the elderly.
Business responded by forming TAFL and engaging the services of professionals experienced in
ballot referenda. The challenge, however, was to develop and implement a strategy for convincing
a majority of voters to vote no on Prop 211. The relevant institution was the public referendum,
which under California law was open to any to qualify a measure provided they obtained the
required number of signatures on a petition. One advantage of the opponents of Prop 211 was that
some voters when undecided or confused by a ballot measure will vote no; i.e., for the known status
quo rather than the unknown consequences of the proposition. The other principal asset of the
opponents was that trial lawyers were disliked by Californians, and their changing the name of their
association to the Consumer Attorneys of California had not changed public opinion.
TAFL was not sufficient to defeat Prop 211, and Dean, Doerr, Proulx, and Young decided to work
for defeat of Prop 211. The keys to defeating Prop 211 were: 1) to raise substantial funds for
television advertisements to bring their messages to voters, 2) to obtain endorsements from opinion
leaders, particularly editors of newspapers and TV stations, and 3) to obtain endorsements from key
politicians, and to enlist the support or at least the neutrality of important voter blocks. Traditional
Democrats and union members were already committed to their trial lawyer allies, but key groups
such as AARP and CalPERS, the California retirement fund, were as yet uncommitted. To
implement this strategy, political entrepreneurs were required and the four committed themselves to
the task.
They needed to mobilize business to contribute funds and to volunteer to oppose Prop 211. This
was a particular challenge because most high tech companies that were more susceptible to
securities fraud lawsuits had a disdain for politics and politicians. However, as Gordon Moore, one
of the most respected business executive in the state and nation, said, There are only two types of
companies in Silicon Valley, those that have been sued and those that are going to be sued. In
addition to raising funds, volunteers from among entrepreneurs and company leaders were required
to talk with editors, politicians, and groups such as AARP. The question was how to accomplish
this in the face of a well-financed group of proponents with important allies.
Two exhibits for use in conjunction with the (A) case are presented on the following pages. The
(B) case presented next describes what was done and the outcome.

165

Teaching the case:


The following questions can be used to guide the discussion.
1. How have the law and the standards for securities fraud lawsuits evolved at the federal and state
levels?
2. What is the strategy of the trial lawyers in securities fraud litigation?
3. What advantages do the trial lawyers have in seeking enactment of Prop 211? Who are their
strong allies and which are more tenuous?
4. What are the principal assets of the proponents and opponents of Prop 211?
5. What strategy should Dean, Doerr, Proulx, and Young choose?
6. How should it be implemented?
7. What messages should the proponents and opponents use in speaking to the public, the key
potential endorsers, and organizations such as AARP and CalPERS?
8. What outcome do you predict for Prop 211?
Update:
Proposition 211 was overwhelmingly rejected by the voters, and the strategy of its opponents was
given much of the credit.
Early evidence indicated that the PSLRA has had its intended effect, since the rate at which federal
courts have dismissed securities litigation cases has increased. A study indicated that since the
PSLRA took effect, 60% of the cases have been dismissed. The rate at which cases are filed has
not diminished, however, and one author of the study indicated that trail lawyers may respond to
the higher dismissal rate by filing more lawsuits.
In a stunning turnabout, in 1999 Milberg Weiss Bershad Haynes & Lerach paid $50 million out of
the partners pockets to settle a lawsuit filed by Lexecon Inc., a legal and economics consulting
company founded by professors at the University of Chicago. Lexecon had charged that Milberg
Weiss had targeted it in a 1990 case solely to discredit it when it appeared for the defense in other
cases. Commenting on the financial blow to Mr. Lerach, Alan Shugart, former CEO of Seagate
Technology, said, It couldnt happen to a nicer guy.
A potentially important case interpreting the PSLRA involved Silicon Graphics. A judge ruled that
investors must allege specific facts that constitute circumstantial evidence of conscious behavior
by defendants. If this decision is upheld upon appeal, it could substantially reduce the number of
frivolous lawsuits filed.
Following the exhibits, the (B) case can be used to continue the discussion or as information on the
strategy chosen, its implementation, and the outcome.

166

Exhibit I
Partial

Company
Adaptec,lne.
AdobeSystems,Ine.
AdvancedMicroDevices
AlteraCorp.
AltosComputerSystems
AmdahlCorp.
AppleComputerInc.
AppliedMagnetics,Inc.
AshtonTate
AuroraElectronics,Inc.
Autodesk,inc.
BrooktreeCorp.
Businessland,Inc.
CadenceDesignSystems,Lnc.
CatalystSemiconductor,Inc.
CipherDataProducts
CompressionLabs,Inc.
ConvergentTechnologies,Inc.
DaisySystemsCorp.
DeLaurentusEntertainment
DigitalMicrowaveCorp.
DigitalSoundCorp.
EquatorialCommunicationsCo.
FileNetCorp.
FinancialNewsNetworkInc.
4thDimensionSoftware,Inc.
GuptaCorp.
IDBCommunicationsGroup
InformixCorp.
IntelCorp.
InternationalTotalizerSystem
KayproCorp.
Magnetek,Inc.
MasstorSystemsCorp.
MediaVisionTechnologyInc.
MicropolisCorp.
NetworkEquipmentTechnologies
NewImageIndustries,Inc.
PerkinElmerCorp.
PlatinumSoftwareCorp.
PriamCorp.
ProximaCorp.
PyramidTechnologyCorp.
QuarterdeckCorp.
Radius,Inc.
RasterOps
RaychemCorp.
Retix
RossSystems,Inc.
SeagateTechnology,Inc.
SierraSemiconductorCorp.
SoftwarePublishingCorp.
SoftwareToolworks,Inc.
SupermacTechnology,Inc.
SymantecCorp.
SynopticsCommunications,Inc.
TandonCorp.
TelevideoSystems,Inc.
3comCorp.
TridentMicrosystems,Inc.
VitesseSemiconductorCorp.
VLSITechnologyInc.
WCTCommunications,Inc.
WestwoodOne,Inc.
WilshireTechnologies,lnc.
WyseTechnology,Inc.

List of Companies Sued by Plaintiffs Represented by


Milberg, Weiss, Bershad, Hynes & Lerach

Case
Disposition
Settled
Dismissed1992
Settled
Settled
Settled
Settled
Tried&Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
N/A
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
N/A
Settled
Settled
Dimissed
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled
Settled

Year
Disposed
Amount
1993$4,317,000

1994
34,000,000
1994
3,000,000
N/A
4,000,000
N/A
13,000,000
1992
16,000,000
1994
4,000,000
1991
10,800.000
1995
3,000,000

1993
5,000,000
1995
5,500,000
1994
8,000,000
1990
175,000
1995
6,000,000
1994
4,500,000
1995
4,700,000
N/A
N/A
1992
13,560,000
1993
18,100,000
1994
19,200,000
1991
3,000,000
N/A
6,380,000
1994
2,250,000
1993
4,997,000
1995
7,250,000
N/A
N/A
1994
75,000,000
1993
11,650,000
N/A
1993
725,000
N/A
9,950,000
1994
4,800,000
N/A
8,000,000
1995
2,150,000
1993
2,300,000
N/A
30,000,000
N/A
3,000,000
N/A
7,000,000
1994
32,000,000
N/A
6,750,000
1995
2,600,000
1992
3,250,000
1995
3,900,000
1995
4,930,000
1995
6,500,000
N/A
19,500,000
1994
7,500,000
1995
5,800,000
N/A
9,300,000
1994
6,000,000
1994
1,500,000
N/A
25,200,000
1995
8,740,000
1994
18,600,000
1993
4,500,000
N/A
18,000,000
N/A
1,800,000
1993
9,850,000
1995
3,150,000
1994
1,400,000
N/A
2,700,000
1995
5,000,000
1989
54,250,000
1994
12,210,000
1992
15,500,000

N/AInformationnotavailable

167

Lawyers
Fees
$1,439,000
11,333,333
1,000,000
1,600,000
4,333,333
5,400,000
1,333,333
3,240,000
1,000,000
1,666,666
1,833,333
2,666,666
30,600
2,000,000
1,500,000
1,566,666
N/A
4,475,000
N/A
6,400,000
1,200,000
N/A
750,000
1,665,666
2,416,666
N/A
25,000,000
4,077,000
241,666
3,316,666
1,600,000
N/A
716,666
766,6h6
10,000,000
1,000,000
N/A
10,666,666
2,250,000
866,666
1,083,333
1,300,000
1,643,333
2,166,666
6,500,000
2,500,000
1,933,333
3,100,000
2,000,000
500,000
8,820,000
2,913,333
6,200,000
1,500,000
N/A
720,000
3,283,333
1,050,000
466,666
900,000
1,666,666
21,700,000
4,070,000
5,115,000

ReprintedwithpermissionfromUpsideMediaInc.

168

Exhibit II
YES ON 211
Retirement Savings and Consumer Protection Act Endorsement List
(8/12/96)
Statewide Groups
(abbreviated)
Congress of California Seniors
American Association of Retired Persons (AARP)
California Democratic Council (CDC)
California Democratic Party (CDP)
California Labor Federation, AFL-CIO
California Keating Victims
California Nurses Association (CNA)
California State Employees Association (CSEA)
- Civil Service Division
- State Retirees
- State Supervisors
- State University
California Professional Firefighters
California School Employees Association (CSEA)
Retired Public Employees Association (RPEA) - CA
United Food & Commercial Workers (UFCW)
American Federation of State, County & Municipal
Employees #101
Service Employees International Union - CA
Golden State Mobile Home Owners League (GSMOL)
Communication Workers of America Retired Members
Council District 9
Older Womens League - California
Source: Citizens for Retirement Protection and Security

169

PROPOSITION 211: SECURITIES LITIGATION REFERENDUM (B)41


As a result of their strategy meetings in July, No on 211 campaign leaders sought the broadest
possible coalition from which resources could be gathered to defeat Prop 211. Support had been
concentrated among the Big Six accounting firms, the California Chamber of Commerce, and
several large technology companies, and the campaign leaders sought to broaden the coalition.
They outlined what they considered to be their strategic imperatives:

Raise funds early in the campaign: The campaign was expected to be highly mediabased, requiring extensive financial resources with which to purchase media time.
Campaign leaders wanted to reserve media early to have access to the best channels
of distribution.
Define the debate and label the initiative: Put TAFLs messages and arguments
before the voters and keep proponents on the defensive. Label the measure as the
Securities Litigation Initiative or even the Lerach Initiative. Avoid references to
securities fraud.
Exceed proponents grassroots efforts: TAFL needed be more aggressive than
proponents in generating grassroots support and demonstrating broad opposition to
Prop 211.
Isolate proponents: Minimize the spread of proponents endorsements and
emphasize the trial attorneys financial support for the measure. In addition, try to
weaken the support of those who already endorsed Prop 211.
Build a bi-partisan campaign: Do not allow the debate to become partisan.
Approach conservatives and liberals, Democrats and Republicans for support and
endorsements.
Implement a strong earned media program: Earned media came from providing
news and information to media sources. The campaign wanted to work proactively
to gain the attention of news media and editorial boards to publicize their position on
Prop 211.
Aggressively utilize paid voter contact activities: Reach voters with credible
messages through mainstream media channels. This would require extensive
television advertising throughout the state. The reliance on paid television
advertising by the campaign was noted in the No on 211 campaign plan:
Television is the most powerful medium we can employ to carry out our
messages to voters. Television is the most dominate information medium in
America todayand with the growth of cable, it is the connection to politics
for people in large cities and the rural areas of California. Television is
where most people get their news. It is where public policy issues are
defined. And it is where modern statewide campaigns are won or lost.

Copyright 1998 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. Reprinted
with permission.
41

170

Promote word of mouth discussions: Get people talking about the initiative.
Stimulate conversation among employees, neighbors and friends. Build voters
comfort with voting against the measure.

Campaign leaders also outlined the messages they wished to deliver:

Prop 211 was written by and for Bill Lerach and other securities lawyers. It would
circumvent restrictions on securities lawsuits imposed by federal level reforms. It
opens the door to an increase in frivolous lawsuits.

Prop 211 circumvents federal reforms passed with bi-partisan support. California
would be the only state to circumvent these reforms.

Prop 211 increases court costs and court congestion by making California a magnet
for securities litigation.

Prop 211 damages seniors and investors by forcing companies to cut dividends, and
divert monies from value-adding activities (such as health and bio-tech research and
development) to pay for legal fees and settlement costs.

Prop 211 damages high-tech and bio-tech companies and jobs. A study by the Law
and Economics Consulting Group was commissioned to determine the economic
effects of the measure. The study concluded that over the next decade Prop 211
could reduce employment in California by as much as 159,000 jobs, reduce tax
revenues by up to $5.1 billion and reduce state output by 1.1% to 1.7%.
Prop 211 is simply bad public policy. In addition to the above messages, opponents
wanted voters to know that the measure does not apply to government officials
responsible for bad investments, the measure could only be changed by another vote
of the people (instead of through the state legislature), and that, in general, securities
litigation reform was a complex issue that should be undertaken through hearings,
analysis and reviews. It should not be decided at the ballot box.
Implementation
Having completed the planning, research and organization phase, campaign leaders split the
remaining campaign into two time periods: Phase Two (late July through August) and Phase
Three (September through election day in November).
The goal of Phase Two was to position the campaign according to its strategy, use that position to
gain key endorsements and build a broad coalition of support, and, having learned the importance
of early fundraising and media buys, to obtain early financial resources through aggressive
fundraising. Phase Three would use these resources to spread the campaigns messages across the
state.
To position the campaign early, TAFL took the unusual step of using paid television advertising
beginning in July. This initial advertising campaign, deployed only in major markets, was intended
to attract the attention of opinion leaders and high-interest voters and signal that Prop 211 would be
strongly opposed. Targeting news programs, public affairs and information shows and talk and
news magazine format shows, as well as talk radio, the campaign developed ads intended to set the
parameters of the debate. In particular, the television ads showed groups of lawyers arriving from
171

New York and being whisked away from the airport by limousine. The lawyers were said to be
coming to file frivolous lawsuits under Prop 211. The emphasis on East Coast lawyers was based
on the fact that many of the plaintiff attorneys firms that had contributed to the campaign
(including the Lerach firm) were based in New York, although most also had offices in California
(Bill Lerach practiced out of the firms San Diego, California office). Research indicated that
voters were particularly skeptical of out-of-state money attempting to influence California law.
The Endorsement Campaign
The advertising campaign was also used to build momentum and support for what was viewed as a
critical series of endorsements expected in August and September. Campaign leaders were eager to
show prospective endorsers that the opposition was well-organized, well-funded, and would be
highly professional and committed to winning. In addition, campaign leaders lobbied intensively
for the support of key state politicians. A new political action committee (PAC) was established
and contributed more than $500,000 to state legislative candidates.
Since 1996 was a presidential election year, endorsements by the presidential as well as state
candidates were viewed as important assets. Campaign leaders viewed Democratic candidates as
particularly critical to building bi-partisan support for the campaign. Despite the Yes on 211
endorsement of the California Democratic Party in July, several prominent state Democrats had
broken from the party on this issue. In particular, State Controller Kathleen Connell, a popular and
influential Democrat, announced her opposition to Prop 211 in early August stating, Im getting
tremendous political heat from my own party. But the issue is too important for me not to speak
about. We cant do anything that would reduce [high-tech companies] willingness and
commitment to retain business in California...[Prop 211 would] put California at a tremendous
disadvantage.42
The campaign leaders were particularly worried about President Clintons position on Prop 211.
He had vetoed the federal securities litigation reforms in 1995, angering many business leaders in
the state. In Silicon Valley, in particular, business leaders had to an unusual degree supported
Clinton in the 1992 presidential election and many felt betrayed by Clintons veto, particularly in
view of Bill Lerachs high profile contributions to Democratic causes and several well-publicized
visits by Lerach with Clinton prior to the Presidents veto. At the same time, while Northern
California had long been a Democratic stronghold, the support of high-profile Silicon Valley
business leaders was highly valued by both President Clinton and the Republican presidential
nominee Bob Dole.
An early boost to the No on 211 campaign came on August 7 when Republican presidential
candidate Bob Dole announced his opposition to Prop 211. He stated that Proposition 211 would
cast a shadow over your economic recovery and burden your state with an unfair and costly law
that has no apparent beneficiaries but a handful of trial lawyers.43
President Clintons endorsement decision was complicated in part by the fact that Bill Lerachs
chief political advisor was also Clintons top California strategist. Nonetheless, after behind the
scenes lobbying by a number of business leaders, Clinton announced his opposition to Prop 211
42
43

San Jose Mercury News, August 15, 1996.


San Jose Mercury News, August 8, 1997.

172

just hours after Dole. Clinton expressed his view that Prop 211 would be highly disruptive to
investment in new companies throughout the country ... It just goes too far and it has national
implications ... It would invite the filing of lawsuits in California that could not be brought under
federal law.44
Proponents of Prop 211 responded that the President had turned his back on his core constituency
more than 100 California consumer, labor and seniors groups. Consumer activist and Green
Party presidential candidate Ralph Nader criticized Clinton for coming out against the initiative
after drinking the milk from the Silicon billionaires campaign cash cow.45 Later in the evening
of his announcement, President Clinton dined at the home of Apple Computer founder Steve Jobs
along with top executives of Intuit, Silicon Graphics, Netscape, Hewlett-Packard, Autodesk, and
Intel.
Both proponents and opponents of Prop 211 viewed the position of the Board of Administration of
the California Public Employees Retirement System (CalPERS) as critical to the success of the
campaign. CalPERS was the largest public pension fund in the nation and was influential in the
investor community. The CalPERS board consisted of political appointees and representatives
appointed by various CalPERS constituencies. Intensive lobbying by both opponents and
proponents preceded the vote by the Board. The debate was brought to the floor at a CalPERS
Board meeting in September during which Bill Lerach spoke in support of the measure and
Stanford Law Professor and Former S.E.C. Commissioner Joseph Grundfest spoke in opposition.
Numerous letters were received and speeches made on both sides of the issue. In the end, the
thirteen member board voted to take no position on Prop 211. To most Prop 211 opponents, this
represented a victory as it deprived proponents of a critical investor endorsement.
During the month of August the No on 211 campaign also succeeded in gaining endorsements
from most major California political figures including Senator Diane Feinstein (D), Governor Pete
Wilson (R) and Attorney General Dan Lungren (R). The two other statewide officeholders, Senator
Barbara Boxer (D) and Lt. Governor Gray Davis (D), did not take a position on Prop 211.
The steady stream of endorsements provided a foundation for continuing press coverage of the
campaign. The No on 211 campaign continued to purchase television advertising through August
to sustain the momentum of the endorsements and maintain a high profile in anticipation of the
broader voter mobilization effort in Phase Three of the campaign. August advertisements were
directed at a broader segment of the public and sought to build on growing general political
awareness associated with the national party conventions. Nonetheless, at the beginning of
September, independent polls showed Prop 211 leading comfortably with a 41% to 27% margin,
with 32% still undecided.
Building Management Support
Armed with broad bi-partisan endorsements, campaign leaders in Silicon Valley targeted three key
business groups for support: CEOs of public and private companies in the high-tech and bio-tech
industries; venture capitalists, securities exchanges, banks and brokerages; and major law firms for
whom technology companies were major clients. For each group a steering committee of industry
44
45

San Jose Mercury News, August 8, 1996.


Los Angeles Times, August 8, 1996.

173

leaders was organized to bring together ideas for gathering support and raising funds. Overall
fundraising targets were established for each industry and progress toward targets was monitored
daily. A fundraising goal of $35.5 million was established (Exhibit I) based on the expected
spending by the proponents and the anticipated paid media advertising and campaign operations.
Since a significant portion of the needed funds was to come from corporations, considerable effort
was directed at gaining the support of CEOs and other senior executives. Campaign leaders
developed a video presentation to inform CEOs of the management implications of Prop 211.
Prominent technology leaders, venture capitalists, and attorneys spoke about the importance of
Prop 211 to the business community and the potential impacts on corporations. The video
discussed the strategy to defeat Prop 211 and the role CEOs could play. The video was distributed
to over 500 business executives.
In addition to the activities in California, information sharing and fundraising luncheons were held
for executives in major business regions such as New England, New York, Texas and Washington
state. Two major out-of-state contributors were the New York Stock Exchange and NASDAQ. A
New York Stock Exchange spokesman explained, We see this initiative as potentially causing
enormous damage to companies, employees and shareholders in California and the rest of the
country. A NASDAQ spokesman added, Normally we dont get into this kind of issue, but there
are not too many like this that would be as damaging to investors, shareholders and companies.
Campaign leaders sought senior level management participation for two reasons: (1) to raise the
funds to sustain the campaign and (2) to build awareness among employees and the general public
of the No on 211 campaign. Senior managers had to decide whether it was in the companys
interest to participate in the campaign, the appropriate role of the company and its management in
communicating to employees on a political issue such as Prop 211, and the degree to which they
were willing to make public statements and raise public support in opposition to Prop 211.
To assist CEOs in deciding these issues, campaign leaders held regular briefings and encouraged
communication between the CEOs active in the campaign and those who had not yet taken a
position. Business leaders were approached in several different groupsTAFL contributors,
members of the Chambers of Commerce, and the top 3000 employers in California. Contributors
were asked to identify campaign liaisons to serve as the contact for TAFL on outreach activities.
CEOs were sent industry-tailored action kits containing sample outreach materials, sample letters to
the editor and messages for employees and customers. More than 100 companies and associations
attended outreach workshops in Silicon Valley, Los Angeles, Orange County and San Diego
sponsored by the Chambers of Commerce and the American Electronic Association.
Campaign Chairman John Young wrote to the CEOs of 2,000 of the top 3,000 employers in
California asking them to approve an outreach program to employees and retirees. A more targeted
database of the top 300 employers was maintained to provide contact and communication channels
between their CEOs and prominent TAFL members. Approximately 90 of the companies agreed to
conduct an outreach campaign. TAFL and its political consultants provided these companies with
outreach guidebooks, employee videos, and sample letters as well as information on providing
voter registration materials and absentee ballots. Campaign leaders were clearly pleased with the
corporate response to the campaign. John Young commented,

174

This is the most galvanizing event in my memory. When you phone up a CEO you
usually have to play telephone tag. They hem and haw before you can wheedle
something out of them. ... Now, executives eagerly offer money and say theres
more, if needed. Executives are also volunteering to call ten other executives as
well, ...46
Company Actions
The decision of whether and how to oppose Prop 211 publicly was one that many executives
considered carefully. Their responses were not uniform, and each company made its own decisions
about campaign involvement. Asked how his company evaluated the decision to become involved
in the campaign, one executive responded:
We have never done anything close to like this, with this kind of involvement. We
may support some causes in one way or another. Generally, the determinant of our
support is, what does it do to the industry? We live in an industrial ecosystem.
If that ecosystem grows and prospers, the company will do well. Thats really
what our interests arewe will support causes which establish the right climate for
the business.
Another executive whose company had also contributed to the campaign explained that the
involvement of companies from numerous industries helped spread the campaigns message and
also served as a sounding-board for ideas on communicating with employees and the public:
We were obviously pursuing the interests of the corporation, but we felt it was
much more effective to do it in the context of the larger industry or group of
industriesit wasnt just high-tech, it was the accountants, venture capitalists, as
well as some others. We attended steering committee meetings in Sacramento and
then we also formed a smaller group in the Bay Area and then met periodically to
do some brainstorming and share ideas about employee communications because
for many of us this was one of the first times we had reached out to employees.
And doing it together with other companies gave you both a greater wealth of
experience and a little bit of comfort both within the company and to let your
employees know that this isnt one company doing it alone.
Intel Corporation engaged in a high-profile public relations campaign on Prop 211. Intel, which
contributed $500,000 to the campaign, announced in October that it would cease making forwardlooking statements and would cancel an analysts meeting in advance of the November 5 election.
Andy Bryant, Intels chief financial officer, explained, We believe that any forward-looking
statements we would make during the next few weeks could be used by someone wanting to file a
lawsuit if 211 passed.47 Sean Crowley of the Citizens for Retirements Protection and Security
dismissed the Intel move as a public relations stunt and another scare tactic.48

46

San Jose Mercury News, September 8, 1996.


Sacramento Bee, October 8, 1996.
48
Sacramento Bee, October 8, 1996.
47

175

Another large company that contributed $500,000 to the campaign elected not to communicate with
shareholders or analysts on issues related to Prop 211. The companys public policy director
explained, [We] thought it was not appropriate because we had so many institutional and
employee investors. What was left over was probably not significant enough to be concerned
with. The company also decided not to issue press releases or grant interviews regarding Prop
211, The people that the press would have probably gone to would have been the executives. We
felt that it was an all-company issue that affected employees and affected people throughout the
state, and so we did not want to give the impression that this was a fat-cat issue. And we didnt
want to give the impression that this was only a high-tech issue, because it wasnt.
Employee Communications

Company actions varied with respect to employee communications as well. Companies initiated
employee voter registration drives, company-wide employee forums on Prop 211, direct
communications from senior management, and a number of other activities designed to raise
employees awareness of Prop 211. One executive reported:
Many of us learned a lot in terms of dealing with employees. This is an industry
where employees are fiercely independent, which is what makes it such an
innovative and creative industry. But, they really balk if they think theyre being
told what to do. It was never our intent to tell our employees how to vote. We
wanted to make them aware of the issue and then tell them why the corporation
had taken the position it did.
Intel Corporation convened employee focus groups to better understand how to communicate with
employees about Prop 211. The focus groups showed that for Intel the most credible method for
delivering messages to employees was through CEO Andy Grove. As a result, a direct video
message from Andy Grove was prepared and presented in the regularly-scheduled quarterly allemployee meetings (Exhibit II). In addition, e-mail messages pointed employees to internet and
World Wide Web sites which provided employees with additional information. According to Senior
Vice President Les Vadasz, employee responses to the companys messages were favorable:
I think that the employees really appreciated that we made an honest case of what
does it mean to us and what does it mean to the industry. Obviously, we have no
ability to tell anybody how to vote, but we do have the ability to tell them what it
means. Never before to my memory have we gone out of our way to tell the
employees that, Hey, theres something really dangerous here, which is
threatening the health and well-being of the whole industry. I am not aware of
one single negative response, although Im sure there was. But there was an
overwhelmingly positive reaction and people appreciated the company telling them
what was going on.
3Com CEO Eric Benhamou addressed employees through a personal e-mail message in which he
discussed his concerns about Prop 211. (Exhibit III) The e-mail stressed the potential impacts of
Prop 211 on the company and the industry while asking employees and their families to be sure to
register to vote, taking advantage of voter registration materials available on the companys
campus.

176

The Statewide Campaign


Concurrent with these employee grassroots efforts, the statewide campaign, headquartered in
Sacramento and run by professional public relations and government relations firms, inundated a
variety of media channels with the campaigns key messages. These campaign officials oversaw
the coordination of paid media, news releases, interviews and editorials, in addition to providing
logistical support to the grassroots campaigns operated by many companies throughout the state
and by the California Chambers of Commerce. Television and radio advertising stressed the threats
to jobs and economic growth and also highlighted the provision that would prohibit restrictions on
attorneys fees. Advertising messages also emphasized the now-widespread endorsements for the
No on 211 campaign. Direct mail, billboards and newspaper advertising in the last weeks of the
campaign hammered voters with the No message. No other electoral or ballot initiative
campaign came close to advertising as heavily as did No on 211.
Over the course of the campaign, the No on 211 organization had succeeded in earning 126
newspaper editorials against Prop 211, giving more than 200 interviews, and being the subject of
more than 175 print articles. Importantly, every major newspaper editorial board endorsed a No
vote on Prop 211.
Despite the progress made in soliciting endorsements, an independent poll in early October showed
the initiative still leading by a 39% to 31% margin. However, the gap had been closing and a large
number of voters remained undecided. By the end of September it was clear that opponents of Prop
211 were going to raise substantially more funds than proponents. (Exhibit IV lists the contributors
of $100,000 or more.) Ultimately the No on 211 campaign spent over $28 million on direct voter
contact. By comparison, campaign finance reports revealed that Prop 211 proponents had spent
only $7.7 million. (Exhibit V)
The Outcome
On November 6, Prop 211 was defeated with a 74.4% no vote, including majority opposition in
nearly every demographic and geographic subgroup. Voters in post-election interviews indicated
their decisions were primarily based on concerns over frivolous lawsuits, lost jobs and damage to
California businesses. Voters also indicated a belief that Prop 211 would actually damage
retirement savings and investments and were wary that Prop 211 would prohibit limits on attorney
contingency fees and grant immunity to elected officials.
Campaign officials attributed the success of the campaign to an ability to define and dominate the
debate with a broad base of oppositionconservatives, liberals, Democrats, Republicans and
independents. By staying on the offensive and focusing on their message, campaign officials
believed they succeeded in moving voters logically from the intuitive support of retirement/
savings protection to the delivery of facts and the potential impacts of the measure.
The consequences of the defeat of Prop 211 for the political involvement of Silicon Valley business
leaders were less clear. A year ago, Silicon Valley was naive and uninvolved, said John Doerr.

177

This community is now politically awake, politically energized and politically concerned.49 Tom
Proulx shared that view saying, I would say the best thing about Prop 211 is it really awakened a
sleeping giant. The technology industry has in the past thought that politics and government did
not affect usit didnt matter. Thats changed, and thats a permanent change.50 Intel's Les Vadasz
said he learned that you better be very serious if you want to win. It takes a lot of muscle and
effort behind it. You cannot just support it by writing a check. I guess we learned what grassroots
really meansits very hard work, even if youre on the right side of an issue.
But not everyone agreed that Silicon Valley had arrived as a political force. One veteran state
capitol observer, insisting on anonymity, commented, Theyve got a long way to go. Theyve
been viewed as ineffective (politically), as people with a high opinion of themselves, who think
because theyve made a lot of money legislators ought to pay attention to what they say. Theyve
come across as very arrogant and very naive.51
Campaign leaders in Silicon Valley knew their efforts had helped to defeat Prop 211. But where, if
anywhere, should they go next? And, were the issues in Prop 211 really settled?

49

San Francisco Examiner, November 7, 1996.


Orange County Register, December 7, 1996.
51
Los Angeles Times, November 4, 1996.
50

178

Exhibit I
TAFL Fundraising Summary Sheet
(as of 12/3/96)
Industry
Accountants
Securities
Venture Capital
High Tech
Insurance
Bio/Health/Pharmaceutical
Entertainment/Tourism
Utility/Oil
Finance
Telecommunications
Real Estate
Legal
Aerospace
Chemical
Food
Manufacturing
Retail
Transport
Other

Goal
$6,000,000
$3,000,000
$4,000,000
$12,000,000
$2,000,000
$1,500,000
$1,000,000
$1,000,000
$1,000,000
$500,000
$500,000
$1,000,000
$250,000
$250,000
$250,000
$250,000
$250,000
$250,000
$550,000
$35,550,000

Source: Pellissier Communications

179

Paid
$6,054,050
$4,551,760
$4,464,579
$11,456,072
$768,000
$2,502,625
$1,035,520
$306,099
$2,416,378
$546,250
$199,150
$846,535
$248,500
$26,850
$255,500
$209,900
$410,700
$296,525
$997,299
$37,592,291

% of Goal
101%
152%
112%
95%
38%
167%
104%
31%
242%
109%
40%
85%
99%
11%
102%
84%
164%
119%
181%
106%

Exhibit II
Selections from Intels Employee Outreach Program
What We Learned from Focus Groups

Employees are comfortable hearing Intels position, but do not want to be told
how to vote.
Employees prefer to hear company messages on company time and not at home.
A presentation is the most effective way to make the point. Letters have
relatively little impact.
An all-employee meeting is the preferred venue for this discussion.
Intels CEO has tremendous credibility with all employees and is by far the best
message bearer.
Argument must be highly data-driven; no emotional appeal, no hype (posters,
flashy brochures).
CEO Video Messages

Introduction: Im here because I am very concerned about the effect of Prop 211 on
our industry and our company
Heres what the initiative means:

Whos behind it

What it would do

Its effect on board/officer

How a specific lawsuit scenario would play


Prop 211 is bad for the high-tech industry:

Small companies are especially hard hit

Intel already has a history of these suits and will be more susceptible if Prop
211 passes
Prop 211 is bad for Intel:

Open communications to employees and the investment community will be


cut back (with resulting effect on stock price)

Resources will move from business to litigation, creating work stops, and we
lose our competitive edge

We assume a defensive business posture which does not work in an


innovative industry. Net results: Hits our bottom line.
Conclusion: I am extremely concerned. Prop 211 presents a serious threat. Study the
facts and understand the implications when you vote this November.

Source: Intel Corporation


180

Exhibit III
To: 3Com Great America
From: Eric Benhamou/HQ/3Com
Date: Monday September 9, 1996, 12:21 PM
Subject: Proposition 211
_______________________________________________________________________
It has been my firm belief over the years to not ask 3Com employees to get involved in any
political or legislative issue that I could not absolutely justify before the 3Com community, the
Board of Directors and the shareholders. Today, I would like to discuss with you an issue that
meets that very strict standardthe need to defeat the frivolous lawsuit Proposition 211 on the
November California ballot for what I believe are very compelling reasons that directly affect
our company and the high-tech sector as a whole. A major component of defeating Prop. 211
will include a voluntary voter registration drive for all employees and their families at 3Com, all
major high-technology firms in the Valley and other prominent private sector companies throughout
the state.
About one year ago, you might recall the debate over financial reporting of stock options that the
Financial Accounting Standards Board (FASB) proposed. 3Com opposed FASBs involvement in
the stock option program because these options are very important to all 3Com employees. More
than five thousand Silicon Valley employees rallied at the San Jose Convention Center to send that
message to FASB. Your involvement in these matters does make a difference!
As employee-owners of 3Com, you must be aware of another economic threat on the horizonthe
securities lawyer sponsored proposition to make frivolous lawsuits easier to file in California.
A small group of securities lawyers have developed a very clever strategy for suing high-tech
companies at the earliest sign of a stock price drop, and then forcing the companies into
settlements. Closely watching the inherent volatility of high-tech stocks, these lawyers use
plaintiffs who sometimes own only a handful of shares to file strike suits against a company and
then engage in months-long searches through company records to try to make their case. Because
these lawsuits are enormously disruptive to businesses in highly competitive high-tech markets,
most companies opt to settle and get on with their business. In fact, from 1989 to 1993, 93 percent
of these securities lawsuits were settled out of court in California. And the plaintiffs security
attorneys have made a fortune in the process.
Over 53% of Silicon Valleys top 100 high-tech firms have been sued in this manner and
forced to pay upwards of $600 million in settlements, depriving these companies of funds for
expanded operations, new jobs, R&D activities and the like.
With the number of lawsuits increasing, the American Electronics Association went to Congress for
a solution to this mounting expense to companies and their stockholders. In a spirit of bipartisanship rarely seen in Washington these days, Republicans and Democrats set aside their

181

partisan differences and overwhelmingly passed a bill that protects investors and deters this small
group of lawyers from filing abusive securities lawsuits in federal courts.
After suffering this loss in Washington, DC, the securities lawyers organized paid workers to solicit
signatures at local shopping centers to put Proposition 211 on the November 1996 ballot and to
enable a landslide of new frivolous lawsuits to be filed in California courts.
Proposition 211 would not only bypass the recently passed federal legislation, but also expand the
power of these lawyers. Unless voters defeat Prop. 211, it would:

undercut the recently passed federal reforms;


apply to every publicly traded company in the United States (all any lawyers would need is one
California resident with one share of stock in any public company headquartered in any state of
the United States and that lawyer could file the lawsuit in California courts);
actually make it easier to file frivolous lawsuits than before the federal reforms;
essentially eliminate the statute of limitations;
allow the use of professional plaintiffs who may buy stock just for the purpose of filing lawsuits
at a later date;
prohibit the California legislature from placing limits on the fees lawyers could charge for these
lawsuits, and some of the fees are over 30%.

Prop. 211 would devastate the California economy by allowing these lawyers to target the best
high-tech California companies that have led the state out of the recent recession.
A recent study conducted by the Bay area Law and Economics Consulting Group found that Prop.
211 would add about $1.5 billion a year to the operating costs of California businesses, reduce the
states economic output by as much as $106 billion, and could cost the state nearly 160,000 jobs.
The study also found that by lowering the standards of evidence and proof for filing a lawsuit, the
initiative would effectively compel California state courts to accept suits that Congress considered
abusive and could not be filing under the new federal law.
3Com has joined 200 other high tech companies and made a donation to the No on 211
campaign. But we all need to make a personal commitment to do more and that involves
registering to vote.
The solution is very clear. If you are not registered to vote, or have not voted in the past couple of
years, you need to re-register. If you have changed addresses, changed names, moved into
California from out-of-state, or moved even across the street, you need to re-register. Some people
think if you dont register to vote you cant be called for jury duty, but thats incorrect since jury
lists are now assembled from drivers licenses. If you drive a car, you will eventually be called
when your turn comes up. Please ask every member of your family over the age of 18 if they are
registered. When in doubt, use the free registration form to re-register.
Registration forms are available in the cafeteria of the Great America campus. Take as many as you
need. They are postage paid, just fill them out and place in any mail box. They must be completed
and in the mail by October 6, 1996.
182

Your active participation in the November 1996 election, with that of your fellow employees and all
our families, will bring enough informed voters to the ballot box so that misguided attempts like
Prop. 211 will not succeed. You will be joining hundreds of thousands of high-tech employees
from around the state in opposing Prop. 211.
As the election draws closer, I will be sending additional information and updates on the No on
211 campaign.
If you have any additional questions about this important matter, please direct your emails to
myself, 3Coms general counsel, or 3Coms Chief Financial Officer [names withheld]
Eric Benhamou
CEO, 3Com
Source: 3Com Corporation

183

Exhibit IV
No on Proposition 211 Contributors of $100,000 and above as of 9/1/96

Securities Industry Association, Inc.


Arthur Andersen & Co.
Coopers & Lybrand, LLP
Deloitte & Touche, LLP
Ernst & Young, LLP
KPMG Peat Marwick, LLP
Price Waterhouse, LLP
Cisco Systems
Intel Corporation
News America Publishing, Inc.
Sun Microsystems
American Insurance Association
Montgomery Securities
Alex Brown
Charles Schwab
Hambrecht & Quist
Merrill Lynch
Oracle
Robertson Stephens
Kleiner Perkins Caufield & Byers
Compaq Computer
Hewlett-Packard
NASDAQ
National Venture Capital Association
New York Stock Exchange
Novell
Warburg, Pincus Ventures, Inc.
Mayfield Fund
New Enterprise Associates
Cypress Semiconductor
Intuit
Netscape
Pharmacyclics
S3, Inc.
Silicon Graphics
Sequoia Capital
Wells Fargo Bank
Wilson Sonsini Goodrich & Rosati

1,135,000
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
1,000,000
600,000
500,000
500,000
500,000
350,000
325,600
300,000
300,000
300,000
300,000
300,000
299,998
276,975
250,000
250,000
250,000
250,000
250,000
250,000
250,000
216,489
210,000
200,000
200,000
200,000
200,000
200,000
200,000
175,484
155,000
150,000

184

American Electronics Association


Technology Venture Investors
Menlo Ventures
Altera
C-Cube Microsystems
Weiss Peck and Greer Ventures
Accel Partners
3-Com
Adaptec
Adobe Systems
Allen & Company
Apple Computer
Bank of America
Cowen
Dell Computers
Electronic Arts
Filenet
Flextronics International
Gap
General Motors
Informix Software
Institutional Venture Partners
Integrated Device Technology
Komag
Macromedia
Maxim Integrated Products
Measurex
Platinum Software
Rockwell
Sandisk
Sutter Hill Ventures
Symantec
Tandem
Tencor Instruments
Thermo Electron Corp.
Vitesse Semiconductor
Xilinx

139,500
155,000
114,213
105,000
105,000
105,000
101,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000
100,000

Exhibit V
TAFL vs. Lerach PAC Expenditures

Campaign Functional Areas


Legal Services
Management
Research/Polling
Earned Media
Outreach/Coalition
Fundraising
Overhead/Admin/Expenses

TAFL
$3,240,822.00
$371,304.78
$370,000.00
$714,440.00
$262,500.00
$373,780.13
$432,599.30
$716,257.79

TAFL
9.2%
1.0%
1.0%
2.0%
0.7%
1.1%
1.2%
2.0%

Lerach PAC
$2,012,171.57
$155,089.49
$788,972.24
$106,569.82
$28,106.66
$334,849.56
$0.00
$598,583.80

Lerach
PAC
18.5%
1.4%
7.2%
1.0%
0.3%
3.1%
0.0%
5.5%

$0.00

0.0%

$1,012,263.25

9.3%

$28,235,535.18
$24,203,763.23
$1,440,433.00
$2,072,000.00
$111,489.95
$201,025.00
$206,824.00

79.8%
68.4%
4.1%
5.9%
0.3%
0.6%
0.6%

$7,708,482.81
$7,246,632.81
$400,000.00
$50,000.00
$11,850.00
$0.00
$0.00

70.8%
66.5%
3.7%
0.5%
0.1%
0.0%
0.0%

$3,902,500.00

11.0%

$156,830.00

1.4%

$35,378,917.18

100.0%

$10,889,747.63

100.0%

Signatures
Direct Voter Contact
Paid Media
Mail
Slates
Web Site
Bill Boards
Canvass
Transfers (1)
Total

Note: (1) Represents funds transferred to organizations not affiliated with the Prop 211 campaign
Source: Goddard*Claussen/First Tuesday

185

Part II Integrative Case


Pharmaceutical Switching
Transparencies are available for this case pharmaswitching.ppt.
I have used this case as the first session in executive education programs with a focus on ScheringPloughs integrated strategy. The basic perspective is that this is a case about strategic competition
not against market rivals (Allegra and Zyrtec) but against nonmarket rivals (WellPoint and
others). The players are WellPoint and payers and Schering-Plough and pharmaceutical companies
more generally. Forced switches are potentially very important to the pharmaceutical industry not
only because of their effects on profits but also because they would disrupt the market strategies of
the drug companies.
The points addressed are:
1. Why a company (Schering-Plough (SP)) should participate in this public decision.
2. The nonmarket issue life cycle and its relation to strategies (see Chapter 2).
3. The market success of Claritin and the stakes for SP and WellPoint.
4. SPs market strategy for its antihistamines including Clarinex.
5. The pressures on the FDA and the institutions and interests that affect it (see Chapter 10).
6. The political responsiveness of the institutions involved (see Chapter 7).
7. The interest group alignment on the forced switch issue and their strengths.
8. Strategy principles and the strategy approach.
9. Formulation of an integrated strategy for SP and its implementation.
10. Formulation of an integrated strategy for WellPoint and its implementation.
11. Wrap-up and developments in the case.
The preparation questions I have used in executive education are:
Preparation questions:
1. Assess the significance of a forced switch for Schering-Plough, Aventis, and UCB/Pfizer.
2. How would a possible switch affect Schering-Ploughs market strategy and planning
process?
3. What is WellPoints overall strategy regarding the prescription and OTC markets?
4. Formulate an integrated market and nonmarket strategy for Schering-Plough.
5. Formulate an integrated market and nonmarket strategy for WellPoint?
6. What are the implications of a forced switch for the pharmaceutical and health insurance
industries?
In leading the discussion I have used the following questions:
1. Should Schering-Plough participate in this government decision-making process? (One purpose
of this question is to engage in a discussion of whether a firm has a right to participate and a right
to pursue its own self-interest. Another purpose is to ask why it should participate? The answer is
because it may be able to affect the outcome. The next question is why it can have influence. One
answer is because it may have information that others do not have. Another answer is that it may
be able to represent the interests of groups that may not be able to represent themselves. To tie this
186

to public policy, the perspective of pluralism is that the public interest is discovered through the
participation, and competition, between the interests in society.)
2. Where is this issue in its life cycle? Is this petition the tip of an iceberg?
3. Why is Claritin so successful? What is the role of DTC advertising?
4. What are the stakes? (Assess the prescription and OTC markets.)
5. What has been SPs strategy for Claritin? How is that strategy threatened by the petition?
6. Which institutions are involved in this decision? (courts, FDA, Congress)
7. Do they make decisions on the same bases? (See the transparencies.)
8. Which interests are aligned here? On which side are doctors? (Doctors are opposed to DTC
advertising because DTC ads put pressure on them to prescribe drugs when they think it is
inappropriate to do so. Most probably trust the FDA panel (of doctors) that it would be safe to sell
Claritin on the OTC market. )
9. What are the concerns of Congress and the Bush administration?
10. What should SPs objectives be?
11. Does SP want to deploy a nonmarket strategy behind the scenes or in public view?
12. How should its strategy be adapted to the institutions?
13. What messages/themes should SP use?
14. What nonmarket strategy should WellPoint use? Which interests are on its side?
15. In the absence of nonmarket strategies, what decision would the FDA like to make? What
process does it have to follow in making its decision?
16. What is likely to happen?
Comments on the analysis of the case follow.
The Four Is
Issues
Immediate term: 1. the switch decision, 2) FDA policy with regard to Rx-OTC switches
Long-term: 1. additional shifts, 2. pharmaceutical prices, 3. insurance coverage for
pharmaceuticals.
An important question is whether there are many other drugs that might be switched from Rx to
OTC status. WellPoint asserts that there are no others, although Clarinex might be a candidate in
the future. It claims that Clarinex is not a breakthrough drug. The pharmaceutical companies
assert that this is just the tip of an iceberg. Surely there must be others, but how many is the
question. Lynn Simpson, a pharmacology professor at the University of Houston, commented that
this was the first switch forced by and insurance company and that this would now become the
strategy of managed care.52
An important issue is whether forced switch issue could spill over to the DTC advertising issue and
to the pricing issue. The pharmaceutical industry apparently spent $2.5 billion on DTC ads in 2000
compared to $26 billion on R&D.

52

The Houston Chronicle, March 9, 2002.

187

Interests and their stakes


Pharmaceutical companies can be grouped into those directly affected by the switch and those only
indirectly affected. Within each of these two categories are pioneer and generic drug
companies. (The generics may prefer the term brand name companies rather than pioneer.)
The three companies with the second-generation antihistamines have big stakes and aligned
interests, even though they are market rivals. Their market planning and strategy approach
could be disrupted. All companies could be affected. S-Ps stake can be readily estimated. IF
SPs margin is 80 percent and U.S. sales are $2.5 billion, Claritins contribution to profit is
$2.0 billion. On the OTC market its profits would be a small fraction of that amount, so SPs
stake is probably over $1.5 billion. How big the stake is for the pharmaceutical industry
depends on how many other drugs could be switched. If the amount of DTC advertising is any
indication of the stake, the stake is very high.
The generic companies that will produce versions of the second-generation antihistamines also
have large stakes, since this is a $5 billion market. WellPoint believes that in December 2002 there
will be both generic Rx and generic OTC versions of Claritin marketed.
There are 140 generic drug companies operating in the United States, and they are represented by
the Generic Pharmaceutical Association (GPHA). The GPHA states that about 10% of the $138
billion pharmaceuticals spending is accounted for by generics. The generic drug companies are
quite concerned about DTC advertising. Bruce Downey, CEO and chairman of Barr Laboratories,
stated on behalf of the GPHA, Delays in the introduction of generic competition, combined with
the nearly $3 billion spent annually on direct-to-consumer marketing for new products that often
displace generic sales, have resulted in a stagnation of the growth of generic substitution. Nearly
two decades after Hatch-Waxman, generic substitution rates hover in the low 40% area, rather than
the 50-65% that was predicted by many experts just a few years ago.53
WellPoint asserts that S-P spent $180 million on DTC for Claritin and only $80 million on
physician advertising. Rx Health Value argues that DTC ads should contain a fair balance of the
disclosure of risks and side effects. The organization wants the FDA to establish a broadlyrepresentative task force to make recommendations for the informational content of DTC ads.
Managed care companies/insurance companies have big stakes and aligned interests, even though
they are market rivals. In addition, state government units that provide care and insurance
(Medicaid) have similar interests and stakes. The stake of these companies is that high prices and
expenditures increase the cost of insurance. This means that fewer consumers will purchase
insurance for pharmaceuticals and employers will begin to limit benefits. This will hurt
WellPoints sales and bottom line.
The switch issue thus pits one huge industry against another huge industry. Both industries are
well-connected and routinely make large political contributions. Big pharma is certainly more
powerful on these dimensions, however. The insurance companies are not loved, and their strength
comes from the governments aligned interest in controlling the rapid growth in health care costs.

53

Testimony, House Energy and Commerce Committee, June 13, 2001.

188

Note that the drug companies want private insurers to provide coverage for prescription drugs.
They also want the buying power of insurers and the government in particular to be limited.
Otherwise, the buyer will use monopsony power to drive prices down.
Doctors may be viewed as concerned about the health of their patients and their own income, and
both would be affected by the switch. What is better for patients is unclear, but if doctors are
interested in making drugs widely available to those who want them, doctors should prefer the
switch. The counterargument is that people will choose to self-medicate and not go to doctors
when they have problems. The cynical view is that the physicians are interested in office visits, and
a forced switch would certainly hurt their income.
Consumers with health care/prescription drug coverage would be hurt in the short-run if the price
of the three drugs on the OTC market is above the co-payment. In the intermediate-run, they would
benefit if the average price of the drugs falls and insurance coverage is maintained for prescription
drugs. In the long-run consumers might or might not be harmed if there is a chilling effect on
research and development that yields lower consumer surplus. Since reductions in R&D would be
at the margin, the effect might not be great if only a few drugs were switched. If more were
switched, the effect could be substantial.
Patients are affected, and the AAN/MA represents some of them. The National Alliance for
Hispanic Health also opposes a forced switch on the grounds that people will not visit their
physicians if they have access to Claritin and hence for some other illnesses will not be diagnosed.
Consumers without health care/prescription drug coverage benefit unambiguously in the short-run
and the intermediate-run. In the long-run they have the same considerations as those with
coverage.
Payers: Most people with health care coverage and pharmaceutical benefits receive them through
their employers as non-taxable fringe benefits. Employers thus ultimately bear the cost of health
benefits and have interests similar to a combination of those of insurance companies and
consumers. Payers have formed an association Rx Health Value that conducts analyses of
pharmaceutical costs and usage. Members include consumer groups such as AARP, employers
such as the auto companies, US West, and the Managed Health Care Association, Blue Cross
Association, and providers including the American Hospital Association, and unions such as the
UAW and the AFL-CIO. Rx Health Value was formed in 1999.
Government as an employer and insurer has same considerations as above. This insurance role will
expand when prescription drugs are included in Medicare.
Medicaid covers some but not most OTC drugs. Medicaid beneficiaries thus could pay more than
they currently pay.
One argument for keeping the prescription requirement is that consumers are more likely to make
mistakes in selecting among the antihistamines. A counter-argument is that physician decisions
regarding which drug to prescribe are influenced by advertising including direct promotion to
doctors.

189

Institutions
The principal institutions are the FDA, Congress, and the Bush administration. The FDA is a
regulatory agency that follows its mandate and administrative rules. Although it is
constrained by both, it has a degree of discretion that can be exercised when it is supported
by professional judgment. It is, however, subject to political pressure from both Congress
and the White House. The White House will appoint a new commissioner and thus will
have a degree of influence on the commissioner. Congress provides the FDAs budget, and
members of Congress frequently make inquiries to the FDA about various dockets and
rules. Congress also exercises oversight and can through legislation direct the FDA to take
particular actions. It frequently does so. A natural opportunity to exercise influence on the
FDA is the Senate confirmation hearing on the Bush administration appointee. Bushs
principal advisor on the FDA is a former pharmaceutical company executive.
What does this issue look like from the point of view of the FDA? A forced switch is an
unprecedented issue, but the FDA has dealt with quite a few drug company-initiated switches. The
difference is that if the FDA orders the switch it will be in opposition to a primary constituency
the pharmaceutical industry.
The FDA maintains that it has the authority to mandate a switch due to a citizens petition. Nearly
40 ingredients have been switched since 1972. The switches can be of two kinds:
1. A complete switch whereby all of the indications and dosage forms are switched from
prescription to OTC status;
2. A partial switch whereby some of the prescription indications and dose regiments are
switched to OTC status and the others remain prescription.54
With respect to procedures FDA may use a wide range of public procedures (e.g., conferences,
meetings, correspondence, hearings) during the process of evaluating the petition. When the FDA
issues a final decision, however, it may be appealed through the court system.55
In making its decisions the FDA does not take into account the economics of the issue. For
example, it does not consider the impact on the incentives for research and development not does it
consider the price of insurance. Those are matters for Congress.
The courts are also relevant, since the probability is high that one side or the other will appeal the
FDA decision. The courts will decide based on three factors: 1) the FDA statutes, 2) the process the
FDA followed and the docket record, and 3) precedents.

54
55

Dr. Janet Woodcock, CDER, FDA, Testimony, House Energy and Commerce Committee, June 13, 2001.
Dr. Janet Woodcock, CDER, FDA, Testimony, House Energy and Commerce Committee, June 13, 2001.

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Information
Important information is whether Claritin would be safe if sold on the OTC market. The advisory
committee has clearly answered that question. The broader issue is whether selling Claritin
over the counter would cause some patients not to visit a doctor and hence not to be
diagnosed as having asthma or some other condition that would require treatment with a
different drug. This is clearly the focus of the pharmaceutical companies, the doctors
associations, and the AAN/MA.
Other relevant information is what would happen to the price on the OTC market. This is
important to the stakes of the companies and the impact on consumers. Both the pharmaceutical
companies and the insurance companies have considerable experience with that market, and the
FDA also is knowledgeable, although it does not take prices into account in its decision-making.
Most people believe that the price would fall substantially.
Timing
The principal institutional arena is the FDA and attention should be given there immediately. The
pharmaceutical companies should also focus immediately on Congress and the White House. Once
the FDA makes its decision, the loser has the option of filing a lawsuit. Whoever is the loser should
file a lawsuit. At this point the loser could also mount a focused political strategy seeking to
reverse the decision. The FDA will probably be sued by both sides.
Distributive Politics
Which side is the stronger? It is close in principle, but in reality it is likely to be the pharmaceutical
industry.
For Schering-Plough the stakes are huge both in the short- and long-term. For Aventis and Merck
the stakes are also large, but neither of the companies is nearly as dependent on second-generation
antihistamines as is SP. As large as these stakes are, the longer-term stakes for the pharmaceutical
industry are huge. There surely are other prescription drugs that could be moved to OTC status,
and insurance companies would surely petition the FDA for a switch.
At best an FDA-imposed switch would increase the uncertainty in the pharmaceutical companies
planning process. At worst the entire strategy and planning process would be disrupted. This
would affect not only the second-generation antihistamines but potentially many other drugs could
be switched to OTC status.
Having the drugs available over the counter would have two benefits for consumers. First, the
price would be lower, so those patients without prescription drug coverage would pay less. For
those with coverage, however, the OTC price was likely to be higher than the co-payment on the
insurance plan. Ultimately, the lower price should be reflected in lower insurance premiums.
Second, consumers who chose to self-diagnose would avoid the cost of a physician visit.
The important factor is whether doctors will be active on the switch issue. Most will not, but those
doctors whose patient-type may not be diagnosed may be active, particularly if they anticipate a

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loss of income from a decrease in patient visits. The two groups mentioned in the case may well be
active.
Patients will generally not be active because the effect on most is very small. Some, however, are
represented by associations such as AAA/NA that wants the three antihistamines to remain Rx.
They can be expected to be active, and one of their tactics may be to bring children to the hearing
to testify about how important it is to see a doctor for diagnosis.
The health care industry has far fewer resources than do the pharmaceutical companies, so if
WellPoint is to mount a political strategy it will have to mobilize others. The potential here is
considerable. The potential comes from the payers who ultimately bear the cost of the
pharmaceuticals. Some payers are represented by Rx Health Value, and it can be expected to be
active on pharmaceutical issues such as this. There are vastly more payers, but mobilizing them
will be a challenge for a single company.
House hearings on pharmaceutical issues were held on this issue, but the Senate has not considered
it.
Jane L. Delgado, President and CEO of the National Alliance for Hispanic Health, a national
association of health and human service providers for Hispanics, supported DTC advertising, DTC
pharmaceutical advertising is more in the model of public health patient education rather than the
Madison Avenue tradition of advertising. Responsible DTC advertising is another tool that
empowers consumers with information that includes both benefits and risks so that the consumer
can make an informed choice.56
The increase in spending on drugs is apparently more accounted for by increased utilization of
prescription drugs, more prescriptions per person, than by higher prices.
Regarding the high prices for pharmaceuticals in the United States, one pharmaceutical industry
executive drew an analogy between defense and pharmaceutical pricing. The United States
provides a defense shield for much of the world, and the U.S. pharmaceutical market provides
revenue to finance worldwide research and development by companies around the globe.
Integrated StrategySchering-Plough
Schering-Plough has a well-integrated strategy with both market and nonmarket components. The
Petition threatens that strategy. The market strategy is 1) to bring in a new drug Clarinex to replace
Claritin when it goes off patent, 2) to advertise heavily to switch consumers and doctors to
Clarinex, and 3) to move Claritin to the OTC market and apply to the FDA for a period of market
exclusivity. (With a voluntary switch and a period of exclusivity Claritin would be the only
second-generation antihistamine on the OTC market during the period of exclusivity.) The
nonmarket component of this strategy focuses on FDA approval for Clarinex, and an attempt to get
a period of exclusivity for Claritin in the OTC market. The nonmarket component involves building
a record for the two approvals. Typically there is little opposition in these processes, so this
primarily involves compliance with FDA procedures. Schering-Plough now must redirect its
nonmarket strategy to stop a forced switch.
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Testimony, House Energy and Commerce Committee, June 13, 2001.

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One feature of the strategic situation is that it may be possible to get a two-year period of
exclusivity in moving Claritin to the OTC market. As I understand it, if the switch is filed under an
New Drug Application (NDA), a two-year period of exclusivity can be granted. When Rogaine
was switched from Rx to OTC, the FDA made a controversial decision in refusing to grant any
exclusivity. The basis for the decision was that no further studies were required.
The best strategy for Schering-Plough is probably to mount a nonmarket strategy aimed a delaying
the FDA decision. This would give it a chance to deploy its original market strategy. Delay can be
achieved through the threat of litigation, by encouraging patients and doctors to contact/lobby the
FDA, attempting to induce members of Congress to intervene with the FDA, and similarly to
induce the White House to intervene. The latter two primarily involve lobbying.
Market strategy
Schering-Ploughs market strategy must, of course, begin with getting its production problems
resolved. The corrections are currently under way.
Once the production problems are resolved, Clarinex should be approved expeditiously. There is
no reason for Schering-Plough to delay introducing Clarinex. Since FDA approval of the switch is
not a foregone conclusion, Schering-Plough should go ahead with its strategy of switching
customers and doctors to Clarinex. S-Ps strategy is to argue that further post-marketing studies on
Claritin are needed before there is a switch. At some point Schering-Plough could submit a
supplemental NDA with post-marketing data that supports Claritins safe use in the OTC market.
This is a delicate issue, however, because the company does not want to lose credibility with the
FDA.
If the forced switch were defeated, Claritin could be switched to the OTC market in December
2002 making it and the generics the only second-generation antihistamines available on the OTC
market. Claritin would be the only one with brand recognition, giving it an excellent opportunity to
establish a high price (for the OTC market).
Counteracting a forced switch Suppose that the FDA ruled that the three antihistamines could be
sold over the counter but their manufacturers chose to restrict their availability. What would likely
happen? One answer is that public pressure to make the drugs available on the OTC market would
be considerable. This would cause one of the manufacturers to decide to move its drug to the OTC
market. There could be a first-mover advantage in doing so. Which company might do it?
Schering-Plough has the most to lose, since Claritin is the best-selling of the three. This suggests
that the manufacturer of Allegra or Zyrtec is the most-likely first-mover. But, Aventis does not
have a replacement prescription antihistamine as Schering-Plough has with Clarinex and neither
does Pfizer/UCB. (Levocetirizine apparently is not a third-generation antihistamine. UCB just
renamed cetirizine in some foreign markets.) Clarinex is not yet approved, however. Another
factor in the analysis is that Claritin will come off patent at the end of 2002, so the other companies
can work backwards on when it will move to the OTC market (is there a three-year extension?)
This suggests that one of the other companies might move quickly to switch to the OTC market.
Uwe Reinhardt predicted, One of them will put it out there and the others will cave.57
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The Washington Post, May 10, 2001.

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In one scenario a forced switch would not be so bad for Schering-Plough. A switch would
eliminate the prescription antihistamines leaving a relatively open field (at least initially) for
Clarinex. The only other competitor would be Sepracors Soltara which was awaiting FDA
approval. If Schering-Plough could shift doctors and patients from Claritin to Clarinex, it would
have a decided advantage over Soltara. Two problems would remain, however. The first would be
to get doctors to prescribe Clarinex rather than tell patients to use one of the OTC non-sedating
antihistamines. Patients with insurance would benefit from the switch even if Clarinex were only
marginally better than Claritin. One strategy for Schering-Plough would presumably be to
advertise Clarinex heavily to prompt consumers to go to their doctor and ask for the new drug.
Doctors financial interests would be aligned with those of Schering-Plough because of the
physician visits the advertising would generate. A better strategy would be to seek approval for
Clarinex for indoor allergies, for which Claritin is not approved.
The second problem was that the insurance industry could petition the FDA to more Clarinex to the
over-the-counter market, but that would likely not happen for years because post-marketing studies
would be required (e.g., there would be no available data such s the Canadian experience). How
likely this was would depend on how safe Clarinex is. The optimal position for a drug company
might be to design the safety of the product so that it was safe enough to be prescribed by a doctor
but not sufficiently safe to warrant OTC status.
WellPoint believes that in December 2002 there will be both a generic Rx version of Claritin and a
generic OTC version.
Nonmarket strategy
The principal nonmarket strategy should be to link allergies with asthma. This would encourage
and build on the strategies of the AAN/MA and the doctors that focus on asthma and diseases
correlated with allergies. The objectives of this focus would at a minimum be to stretch the FDAs
decision-making process. This would give S-P an opportunity to deploy its market strategy of
migrating patients from Claritin to Clarinex.
The strategy of the generic drug companies is of interest. A forced switch would put them into the
OTC market as well. This would certainly result in lower prices but would likely result in lower
profits. They might well oppose a switch but may be silent on this issue because their drugs have
not yet been approved.
S-P will surely argue that only the manufacturer can adequately monitor the post-marketing
experience with a prescription drug and hence it should decide when to switch it to OTC status.
If political strategies are to be directed at Congress or the White House, one issue is whether they
should be conducted through an industry association or by individual companies. The companies
have different interests (e.g., due to remaining patent lives), so they might act individually. The
companies are market rivals, but they can be nonmarket allies. In this case the best strategy is for
each company to conduct individual nonmarket strategies with the understanding that the other
companies will be doing the same.

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A legislative strategy has an immediate component and a conditional component. The objective of
the immediate component is to influence the switch decision. The conditional component is to
reverse a switch decision if it occurs. This would require new legislation. This would probably
involve inserting a directive to the FDA into an appropriations bill or a related piece of legislation.
One strategy that might be used is to argue that label comprehension studies are needed. These
would have to be done by the pharmaceutical companies and would delay any forced switch.
One nonmarket strategy alternative would be to file a late patent followed by a patent infringement
lawsuit. This would delay entry of the generics. See the Chapter 12 case Patent Extension:
Protection or Manipulation?
Could the drug companies or the insurance companies mount grassroots pressure among their
stakeholders for their side of the issue? Possibly, but much of the public does not have favorable
impressions of either insurance companies or drug companies. The best possibility is alreadyorganized patient groups.
Both the pharmaceutical and the insurance industries have aggressive nonmarket strategies.
According to the Center for Responsive Politics, the pharmaceutical industry was 12th in political
contributions in the 2000 election cycle, contributing $26.3 million. Sixty percent was in soft
money. The insurance industry was sixth with contributions of $40.4 million, with 40% in soft
money. Blue Cross-Blue Shield was the largest insurance contributor with $2.0 million, but it is a
national association and not just Blue Cross of California. WellPoint was not one of the top 20
insurance contributor, contributing only $10,550. Schering-Plough was 6th among the
pharmaceutical companies with $1.2 million in contributions, most of which went to Republicans.
Pfizer was 2nd with $2.3 million, and Aventis was 10th with $0.8 million.
The Center for Responsive Politics reported that Schering-Plough spent $9.2 million on lobbying in
1999, of which $2.3 was for 17 lobbying firms. (Halls list of the individuals hired is accurate.)
Pfizer spent $3.8 million, and Aventis spent $760,000 on hired lobbying.
Lawsuits
Threatening a lawsuit is a good idea, since it will make the FDA move cautiously in its decisionmaking. If the FDA rules that the drugs are to be sold over the counter, the companies will file
lawsuits. The grounds for lawsuits could range from the statutory authority of the FDA to the
process used for the approval. The companies could, for example, argue that the FDA has not
followed precedents established in other manufacturer-requested Rx-OTC switches.
If the FDA rejects the Petition, WellPoint could file a lawsuit, but the grounds for a lawsuit are not
clear.
The pharmaceutical companies may have better prospects in the courts if the decision goes against
them than does WellPoint.
Richard F. Kingham, a lawyer who has represented pharmaceutical companies but who was
testifying on his own behalf in opposition to a forced switch, said that beginning in the 1980s the

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FDAs switch review procedure essentially always included an NDA or an NDA supplement.
Kingham also discussed the bases for a lawsuit challenging a forced switch. He referred to FDA
precedents, the due process provision of the Constitution, the administrative procedures
requirements, and property rights. He stated, The company has proprietary rights in its NDA data,
which cold not be used without consent, regardless of the regulatory procedures followed.58
By statute a patent infringement lawsuit stays the introduction of a generic by up to 30 months
while the case is being considered. Some pioneer drug companies file new patents just before the
existing patent expires, and then claim patent infringement.
To illustrated the complexity of the patent-generic drug mix, in May 2001 seventeen consumer
groups filed a lawsuit against AstraZeneca, a prescription drug company, and the generic drug
company Barr Laboratories. The lawsuit argues that AstraZeneca and Barr entered into an
agreement under which Barr agreed not to introduce their generic version of Nolvadex in exchange
for a lump-sum payment of $21 million and the right to sell the prescription drug. The FTC was
concerned with such agreements and negotiated a settlement with Aventis in the case of a delay in
the introduction of a generic version of one of its prescription drugs. PhRMA argues that such
settlements are efficient because they eliminate litigation expenses.
In April 2001 the FTC under the Clinton administration voted unanimously to file civil charges
challenging an agreement among Schering-Plough and two generic drug companies that delayed
the introduction of the generic drugs.
WellPoint
WellPoint came up with the idea of a citizens petition as part of its review of options for dealing
with the rapid increases in pharmaceutical spending. Antihistamines was a therapeutic class with
one of the largest increases. In their review they kept coming up with the same themethe second
generation antihistamines are safer than the OTC antihistamines. They found this option in a
review of the code for the FDA, in Section 21 of the Code of Federal Regulations, Paragraph 31.0.
WellPoint did not have to hire an archeologist to firm the provision for a citizens petition; it was
just there.
WellPoints strategy is to press on with the Petition. It has the advantage as a result of the advisory
committee votes, and it wants to press the FDA to follow the committees recommendation.
The tactics with the FDA focus on the use of extant studies from other countries, such as the
study from Canada. The objective is to have the FDA accept these studies and not require any
post-marketing studies in the United States.
Why does WellPoint have a long-term interest in this issue if when Claritin is moved to the OTC
market patients are switched to Clarinex? The answer according to WellPoint is that Clarinex
is not a significant improvement over Claritin, so WellPoint will not cover Clarinex because
there is an OTC drug Claritin that is as effective.
S-Ps strategy is to advertise Clarinex to induce consumers to ask their physicians for it. This will
put pressure on the physicians, since many patients will want the new drug. The patients will then
58

Testimony, House Energy and Commerce Committee, June 13, 2001.

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be mad at either their physician for telling the patient to go to the OTC market or their insurer. In
particular, Clarinex has an advantage over all other drugs in that it is both nonsedating and
approved for both indoor and outdoor allergies. WellPoint indicated that it would not include
Clarinex in its formulary, but it is likely to come under pressure from subscribers to do so.
If Clarinex is not a breakthrough drug or major improvement over the second-generation
antihistamines, would it be a candidate for a forced switch? Perhaps in the long-run but probably
not in the short-run, since post-marketing data will need to be collected. Note that there is no
overseas studies of Clarinex at this point, since it has not yet been sold anywhere.
One issue pertaining to WellPoints petition is whether it filed it too late. Hindsight suggests that
the answer is yes, but note that the FDA delayed nearly three years before the advisory committee
was convened. If the FDA had acted expeditiously, a decision could have been reached well before
the patent on Claritin expired. Perhaps, however, WellPoint should have anticipated this and filed
the petition two years earlier. This seems an unfair criticism, since WellPoint was a nonmarket
entrepreneur in this case and came up with the novel idea for a petition when it did. An appropriate
criticism may be that WellPoint should have worked harder to speed the FDA in setting up the
review process.
Prices
What might happen to the prices of prescription drugs if they are sold over the counter? Would
advertising increase or decrease? Would distribution costs decrease? The prescription drugs are
already available at WalMart. Would price competition drive prices down? William ODonnell of
Schering-Plough said, Were they to go over-the-counter, they would probably be priced as a
premium product and costs to consumers would be higher than their co-payments.59 This could be
true, but the price should fall considerably from the current level.
In the June 13 House hearings WellPoint presented a comparison of the prices of Claritin, Benadryl,
and Clor-Trimetron in chain drug stores in Canada and the UK, showing that they were all priced at
the same level. WellPoint argued that Claritin would be priced at the level of those drugs in the
U.S. if it were on the OTC market. That price would be about $15 a month. WellPoint argued that
the average co-pay for a prescription drug in the U.S. is $17. In addition, the average co-pay for a
doctors visit is $17.
Larger issuepharmaceutical expenditures
The longer-term considerations pertain to the solution to the pharmaceutical expenditure problem
and to which drugs the solution should first be applied. The objective of the insurance industry is
to reduce its expenditures by either reducing the price of pharmaceuticals or moving
pharmaceuticals off its budget. Blue Cross of California chose antihistamines, which in some other
countries are available over-the-counter. The long-term objective is to obtain lower prices for
pharmaceuticals and then to offer insurance options providing for a variety of types of coverage for
pharmaceuticals.
A potentially powerful group here is the payers. WellPoint has joined with other payers to form Rx
Health Value (www.rxhealthvalue.com) to address the issue of rapidly increasing health care
59

The Sacramento Bee, May 11, 2001.

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expenditures. The organization began with a study of drug expenditures increases that reported that
prescription drug expenditures had increased nearly 25%. How active politically Rx Health
Partners will be remains to be seen.
Another strategy issue is the type of relief to be sought. One possibility was to seek regulation of
pharmaceutical prices. The grassroots opposition to the Clinton administrations health care reform
initiative caused it to go down in flames in 1993. Although various types of price regulation had
been discussed from time to time, the prospects during the Bush administration were remote at best.
Price regulation would have to clear Congress, since there was no authority for such regulation of
pharmaceuticals. The second basic alternative was to use competition to drive down expenditures.
The only ways to do this were to rely on generics or to move pharmaceuticals from the prescription
to the over-the-counter market. When generics could be brought to market was fixed by law and
would require action by Congress to change. Although restrictions on generic drugs had been
relaxed in the past, it was a result of very heated politics and intense Congressional action.
Changes also took many years to achieve. Such a change seemed highly unlikely. The third basic
alternative is to rely on monopsony power of the government, e.g., through Medicare, or through
joint purchasing program among insurance plans.
Maine passed a law empowering the state to negotiate and purchase prescription drugs for its
citizens. The state also can prior authorize drugs for Medicare. PhRMA filed a lawsuit against
the state, and a federal court issued an preliminary injunction against the state preventing it from
implementing the law. The U.S. Court of Appeals lifted the injunction in May 2001.
Related issue: DTC marketing
A 1997 revision to the FDA rules change removed the brief summary of risks requirement which
allowed the current DTC advertising. DTC marketing has become a major issue in the industry. It
is a source of considerable profits for the industry, and the industrys argument that the advertising
involves consumers more actively in their health care decisions is important. However, the
advertising increases the use of drugs with the average number of prescriptions per patient
increasing in recent years. Even if prices have remained constant, the increase in prescriptions
increases pharmaceutical expenditures. Critics complain that the DTC marketing not only results in
higher expenditures, but it forces doctors to prescribe expensive drugs when they are not needed.
Many doctors do not like DTC advertising because it puts them under pressure. That is, when
consumers ask their doctor for a drug by its brand name, doctors have difficulty saying no or
telling the consumer to use an OTC drug. One reason doctors feel they have to be responsive to
consumer requests is that HMOs and other health care providers have decided they need happy
clients. They have introduced feedback systems on office visits with doctors, and some now pay
bonuses for patient satisfaction and other indicators of quality. These include WellPoint as well as
Blue Cross of California and Harvard Pilgrim Health Care of Massachusetts.
Despite the concerns of doctors regarding DTC marketing, the American Medical Association
(AMA) has not taken a position on the issue, although the AMA is studying the issue.

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Developments
At the end of 2001 Clarinex received FDA approval for one indication, and in February 2002 it
received approval for the treatment of seasonal outdoor allergies. Initially, Clarinex was priced
18% below the price of Claritin. Approval had been delayed by negotiations between the company
and the FDA over fines to be imposed as a result of its manufacturing problems.
When the FDA approved Clarinex, SP began an aggressive DTC advertising campaign. This
approval was for seasonal, outdoor allergies, and in February 2002 Clarinex was approved for yearround indoor allergies. This was also important because Claritin had not been approved for indoor
allergies, so SP could advertised that Clarinex was superior to Claritin. Moreover, this gave
Clarinex an advantage over Allegra which was not approved for indoor allergies. Zyrtec was
approved for both indoor and outdoor allergies, but it was not approved as non-sedating as were
Allegra, Claritin, and Clarinex. (Recall that Allegra and Claritin were approved for use by pilots
but Zyrtec was not). Early indications were that Clarinex was selling well.
When Clarinex was approved by the FDA, WellPoint announced that it would not include the drug
in its formulary, so its policyholders would not be reimbursed for Clarinex. Robert Seidman said,
Theres no room for prescription drugs that provide no value over OTC versions.60
In March 2002 Schering-Plough announced that it was filing a petition with the FDA to switch
Claritin to the OTC market. Commentators believed that the reason was that American Home
Products and Johnson & Johnson had announced that they would introduce generic versions of
loratadine once Schering-Ploughs patent expired in December 2002. SP was silent about its
pricing strategy for the OTC market. Consumers with insurance were expected to have to pay
somewhat more for Claritin on the OTC market compared to their current co-payment, but the cost
of their managed care insurance would be lower. SP lost about 5% of its market value upon the
announcement.
SP had been unsuccessful in extending the patent for Claritin, so the patent would expire in
December 2002. The FDA panel was not scheduled to meet until November 2002, FDA approval
would occur at about the time the patent expired. SP had several reasons for this move. First, the
voluntary switch would leave WellPoints petition moot. Second, American Home Products and
Johnson & Johnson had announced that they would market OTC generic versions of Claritin
forcing SPs hand. Third, by switching Claritin to the OTC market, generic versions of Claritin
could not be marketed on the Rx market. To accomplish this, SP had to obtain one additional
approval, as indicated in the next paragraph.
In April 2002 an FDA panel endorsed OTC Claritin for the treatment of hives. If the FDA agrees
with this conclusion, it would be a major victory for Claritin, since OTC Claritin would thus have
the identical label as the Rx Claritin label. FDA regulations do not allow the identical drug to be
sold simultaneously on the Rx and OTC markets. This means that if the switch to the OTC market
is approved as expected (the panel meets in November 2002) there can be no generic versions of
Claritin sold on the Rx market. The generic versions of Claritin would thus have to be marketed on
the OTC market. This would also reduce the competition for Clarinex on the Rx market.
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The Wall Street Journal, March 8, 2002.

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The voluntary shift has some advantages. The switch would preclude generic versions of Claritin
from being sold on the prescription market, since FDA preclude the sale of the same drug on both
the prescription and the OTC markets.
This left Allegra and Zyrtec in difficult positions because they would have to compete against
Clarinex on the prescription market with sales drained by the availability of Claritin on the OTC
market. They were also still subject to the WellPoint petition. WellPoint also raised the copayment on Allegra and Zyrtex from $30 to $40.
As of May 2002 the FDA had not acted on the WellPoint petition. One reason reportedly was that
the FDA staff preferred to wait until an FDA commissioner was in office. Because of continuing
disagreements between the pharmaceutical industry and other health care interest groups had been
unable to agree on a commissioner. Hence, the Bush administration had not yet nominated a
commissioner.
One important issue is whether this petition is the tip of an iceberg as Bert Spilker states in the case.
The answer seems to be yes in the sense that there are a number of other drugs that may be
candidates for a switch. The two Cox-II inhibitors, Celebrex and Vioxx, are believed to be
candidates, as may be Viagra. In addition, non-steroidal anti-inflamatory drugs may be candidates.
These drugs, along with the second-generation antihistamines, account for much of the DTC
advertising. This suggests that as one commentator put it, DTC = OTC. That is, if a drug is safe
and effective and heavily advertised, it should be sold OTC. Conversely, if a drug is not safe for
sale OTC, then it should not be advertised directly to consumers.
A related nonmarket issue in this is thus whether DTC advertising, which may be $4 billion a year,
should be restricted. This is a controversial issue that will be on the nonmarket agendas of
pharmaceutical companies in the immediate term.
Other developments:
In May 2002 the FDA and SP reached a consent decree under which SP agreed to pay a fine of
$500 million for production quality problems at its facilities in New Jersey and particularly Puerto
Rico. SP had spent $60 million to improve its quality control and hired 500 additional employees,
but the consent decree required it to do more. SP agreed to discontinue production of 70 minor
products, and to make a number of specific improvements. The consent decree was to last for five
years.
Two days before the consent decree was announced, SP disclosed that the FDA had begun a
criminal investigation of its Puerto Rico plants. This may have been instigated by Public Citizen,
which had written to the FDA alleging that deaths had occurred because SP had failed to include
albuterol in its asthma inhalers.
Separately, the FDA did not approve Sepracors Zoltara allergy drug. The FDA stated that the
company had not shown that the drug did not cause heart problems. Sepracor lost half its market
value on the day of the announcement. Sepracor reported that it found no evidence of heart

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problems in its clinical trials. Zoltara is a derivative of Hismanal, which was withdrawn from the
market in 1999 because of concerns about side effects, including heart irregularities. Sepracor had
developed derivatives of allergy drugs for Aventis and Schering-Plough, and those drugs became
Allegra and Clarinex, respectively.
In 2001 the Prescription Access Litigation Project filed a lawsuit against SP alleging that DTC
advertisements for Claritin were deceptive.
The state of Schering-Plough at the end of 2001 is assessed in At Schering, Optimism and
Problems, The New York Times, November 15, 2001. Also see Schering Plough Faces a Future
with Coffers Unfortified by Claritin, The Wall Street Journal, March 22, 2002.
Copyright 2002 by David P. Baron. All rights reserved. Reproduced with permission.

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