We analyze the risk-taking incentives of a financial conglomerate that combines a bank and a non-bank financial intermediary. The conglomerate's risk-taking incentives depend on the level of market discipline it faces, which in turn is determined by the conglomerate's liability structure. We examine optimal capital regulation for standalone institutions, for integrated conglomerates and holding company conglomerates. We show that, when capital requirements are set optimally, capital arbitrage within holding company conglomerates can raise welfare by increasing market discipline. Because they have a single balance sheet, integrated conglomerates extend the reach of the deposit insurance safety net to their non-bank divisions. We show that the extra risk-taking that this effect causes may wipe out the diversification benefits within integrated conglomerates. We discuss the policy implications of these results

This paper reviews the economic theory of regulation and surveys the empirical evidence on its application to past and recent changes in U.S. securities regulation. The theory provides multiple potential motives for regulation and cautions the empirical researcher against naïve modeling of the costs and benefits of regulatory change. Moreover, the nature of the regulatory process compounds the standard pitfalls of empirical analysis such as endogeneity and confounding events. Productive empirical techniques include the development of cross-sectional predictions of the effects of regulation as well as the use of unregulated control samples. An important avenue for future research is a more refined estimation of the extent to which regulation has unintended consequences

We analyze the optimal portfolio policies of expected utility maximizing agents under VaR Capital Requirement (VaR-CR) regulation in comparison to the optimal policy under exogenously-imposed VaR Limit (VaR-L) and Limited-Expected-Loss (LEL) regulations. With VaR-CR regulation the agent strategy consists of simultaneous decisions on both the portfolio VaR and on the implied amount of required eligible capital. As a result, the performance of VaR-CR regulation depends on its design (the parameter n) and the agent preferences. We show that an optimal VaR-CR regulation allows the regulator on the one hand, to completely eliminate the exposure to the largest losses, which may jeopardize the existence of the institution, and on the other hand, to restrain the portfolio exposure to all other losses. These results rationalize the current Basel regulations. However, the analysis shows also that there is an optimal level of required eligible capital from the regulator standpoint. Counter-intuitively, any requirement above this optimal level is inefficient as it leads to a smaller amount of actually maintained eligible capital and thereby to a larger exposure to the most adverse states of the world. Unfortunately, the current Basel’s range of required levels (n=3–4) is within this inefficient range. Moreover, with an inefficient regulation the agent might employ an inefficient reporting and disclosure procedure

Ostensibly, the SEC's new round of regulatory activity is motivated by a bout of well-publicized business scandals and an explosive increase in financial innovations and instruments. Many critics of the “new” SEC question the proportionality and usefulness of the responses, which move the SEC well beyond reliance on disclosure and promotion of transparency. Others argue that more heavy-handed and far-reaching regulation is necessary given the vast changes in financial markets, the increasing importance of (largely unregulated) hedge funds and private equity, and corporate scandals that allege fraud and deception. This paper provides a rationale for studying recent regulatory changes and for addressing the overarching question of how to define the boundaries of SEC intervention in financial markets. The study provides an overview of papers in this special issue and concludes with suggestions for how policymakers can use research to better evaluate the costs and benefits of regulation

This paper reviews academic studies of bank capital regulation in an effort to evaluate the intellectual foundation for the imposition of the Basel I and Basel II systems of risk-based capital requirements. The theoretical literature yields general agreement about the immediate effects of capital requirements on bank lending and loan rates and the longer-term impacts on bank ratios of equity to total or risk-adjusted assets. This literature produces highly mixed predictions, however, regarding the effects of capital regulation on asset risk and overall safety and soundness for the banking system as a whole. Thus, the intellectual foundation for the present capital-regulation regime is not particularly strong. The mixed conclusions in the academic literature on banking certainly do not provide unqualified support for moving to an even more stringent and costly system of capital requirements. These widely ambiguous results do suggest, however, that assessing the implications of capital regulation for balance-sheet risk and monitoring effort in diverse banking systems is an important agenda for future theoretical research in the banking area

This study investigates three related questions: (1) Why did some firms provide private earnings guidance to analysts before Regulation Fair Disclosure? (2) How did the exogenous shock of Regulation Fair Disclosure affect these firms' disclosure policies? (3) What are the economic consequences of this disclosure regulation? To address these questions, I develop a new measure of private earnings guidance. Consistent with theory, I find that firms were more likely to provide private earnings guidance if they had higher proprietary information costs, and if their earnings were more predictive of other firms' earnings. Policymakers enacted Regulation Fair Disclosure to stop private earnings guidance, but they also intended for managers to replace private earnings guidance with public earnings guidance, thereby improving the information environment. However, I find that roughly half of the firms that I classify as relying more on private earnings guidance replace private earnings guidance with non-disclosure instead of public earnings guidance, and as a result, these firms suffer significant deterioration in their information environments. Consistent with theory, firms are more likely to replace private earnings guidance with nondisclosure if they have lower information asymmetry and higher proprietary information costs. On the other hand, firms that replace private earnings guidance with public earnings guidance, on average, prevent significant deterioration in their information environments. Evidence that firms respond to disclosure regulation as predicted by theory can help policymakers anticipate which firms' information environments are likely to be adversely affected by new disclosure regulations

The Sarbanes–Oxley Act of 2002 and recently modified exchange listing requirements impose uniformly high levels of outside director monitoring on all firms. However, recent research in finance suggests that corporate governance structures, including boards of directors, are chosen endogenously by firms in response to their unique operating and contracting environments. Using the relative costs and benefits of outside director monitoring as a benchmark, I find significant cross-sectional variation in the wealth effects around the announcement and passage of these regulations. I find that firms which have high monitoring-costs and fewer benefits from outside monitoring benefited less from the regulations. In particular, I find that the wealth effects around the passage of these new regulations are positively related to firm size and age, and negatively related to growth opportunities and the uncertainty of the firm's operating environment. The results suggest that a blanket “one size fits all” governance regulation maybe detrimental to certain firms, particularly young, small, growth firms operating in uncertain business environments, that are costly for outsiders to monitor

Regulation Fair Disclosure (“Reg FD”), adopted by the U.S. Securities and Exchange Commission in October 2000 was intended to stop the practice of “selective disclosure”, in which companies give material information only to a few analysts and institutional investors prior to disclosing it publicly. Our analysis shows that the adoption of Reg FD caused a significant shift in analyst attention, resulting in a welfare loss for small firms, which now face a higher cost of capital. The loss of the “selective disclosure” channel for information flows could not be compensated for via other information transmission channels. This effect was more pronounced for firms communicating complex information and, consistent with the investor recognition hypothesis, for those losing analyst coverage. Moreover, we find no significant relationship of the different responses with litigation risks and agency costs. Our cross-sectional results suggest that Reg FD had unintended consequences and that “information” in financial markets may be more complicated than current finance theory admits

We document that Regulation Fair Disclosure has reduced differences in information quality between investors prior to quarterly earnings announcements consistent with the intent of the regulation. This reduction is driven by small firms and high technology firms, rather than the large firms targeted by the SEC, which suggests that selective disclosure among large firms may have been much more limited than what was presumed by proponents of FD. In addition, we document that FD has decreased the average information quality of investors in small and high technology firms in the period prior to an earnings announcement while having no lasting effect on other firms. Taken together these two results suggest that, for small and high technology firms, FD succeeded in eliminating selective disclosure but also lowered the average quality of information available about these firms

Using industry-level data disaggregated by states, this paper finds a positive impact of trade liberalization on (the absolute values of) labor demand elasticities in the Indian manufacturing sector. The magnitudes of these elasticities turn out to be negatively related to protection levels that vary across industries and over time. Furthermore, we find that these elasticities are not only larger in size for Indian states with more flexible labor regulations, they are also impacted there to a larger degree by trade reforms. Finally, we find that the reforms have led to a reduction in the share of labor in total output and value added, possibly due to the reduction in the bargaining power of workers