Regulatory arbitrage refers to structuring activity to take advantage of gaps or differences in regulations or laws. Examples include everything from tax shelters and shadow banking to the cross-border mobility of corporations. Scholarly discussion of regulatory arbitrage has tended to focus on possible solutions: harmonization, conflicts-of-law rules, and anti-avoidance regimes.

In a new paper, forthcoming in the European Business Organization Law Review, I focus instead on developing a better understanding of the limits to regulatory arbitrage. Given the benefits to companies that engage in it, why don’t we see more regulatory arbitrage? What constrains it? The most notable past work on this topic is an article by Victor Fleischer that identifies legal constraints, Coasean transaction costs, professional constraints, ethical constraints, and political constraints.

Drawing upon a range of examples from the tech industry, I add to the existing literature by exploring how social license and the bundling of laws and resources can act as constraints on regulatory arbitrage. Further, I explain how the presence of alternative strategies for interacting with and responding to the law demonstrates the limits of regulatory arbitrage.

The first point starts from the observation that regulatory arbitrage can affect stakeholders and impose costs on communities. Particularly when a company aggressively maneuvers around a law in a way that creates perceptible social costs, the public can react negatively and ultimately affect whether, and the extent to which, such a strategy is a valuable course of action. Because regulatory arbitrage can be viewed as circumventing obligations to society or unfairly taking advantage of loopholes, its propensity to provoke social pushback may be greater than other forms of business decisions more generally.

Consider, for example, Uber’s controversial arbitrage of employee status for its drivers and the series of scandals the company sparked in 2017 that eroded public trust. As a result, Uber faced pressure for governance changes, additional governmental oversight, and restrictions on its license to operate. The strength and effectiveness of public approval and trust as a constraint may vary by company, industry, community, and across different time periods. For instance, in an era of tech backlash, social opprobrium could be triggered more quickly for consumer-facing tech companies or have greater costs.

The bundling of laws and resources can also act as a constraint on regulatory arbitrage. Opportunity arises not in isolation but within a system of laws and in light of other needs and preferences such as investment capital, workforce talent, brand value, and personal benefits. The more that laws can be discretely chosen, the greater potential for regulatory arbitrage. And conversely, the greater the extent to which a law is bundled, the less room there may be for regulatory arbitrage to function as a valuable strategy.

Facebook, for instance, recently modified its terms of service so that data from 1.5 billion users, previously managed from its office in Ireland to benefit from low corporate tax rates, would instead be handled by its U.S. headquarters, which falls under less strict privacy laws. To take another example, despite high tax rates and cost of operations, California has been one of the world’s great incubators for innovative companies, with its particular mix of laws and resources, including strong intellectual property protection and employment law that facilitates worker mobility.

Finally, in some instances, gaps or differences in laws exist but are part of a regulatory environment that is generally prohibitive for certain kinds of new business models or innovations to operate on a global scale. In these circumstances, alternative strategies to change laws rather than arbitrage them may offer more promising outcomes. Jordan Barry and I have referred to this activity as “regulatory entrepreneurship” – where companies “pursu[e] a line of business in which changing the law is a significant part of the business plan.”

For example, electric scooter company Bird did not launch only in locations with favorable laws – jurisdictional arbitrage would have limited the company’s ability to grow and raise funds. After facing setbacks in some cities, Bird has often leveraged support from users and lobbied to come back and play by new rules that city officials are pressured into rolling out. When circumventing the law or re-categorizing would not be sufficient or plausible at scale, regulatory entrepreneurship represents a contrasting strategy that reveals the limits of arbitrage.

This post comes to us from Professor Elizabeth Pollman at Loyola Law School, Los Angeles. It is based on her forthcoming article, “Tech, Regulatory Arbitrage, and Limits,” available here. The article was also featured on the Oxford Business Law Blog.