To regulate or not to regulate

Kevin Lewis

February 04, 2013

The Disciplining Role of the Market Versus Government Regulation: The Case of Sarbanes-Oxley and the Earnings Quality of M&A Targets

Ilanit Gavious & Mosi Rosenboim
American Law and Economics Review, forthcoming

This study examines whether and how the passage of the Sarbanes-Oxley Act (SOX) affected earnings quality, proxied by accrual measures, prior to mergers and acquisitions (M&A). Given that the capital markets underwent unusual vicissitudes in the period leading up to the passage of SOX, we subdivide the pre-SOX period into four sub-periods: (1) the pre-technology bubble (1992-1997); (2) the technology bubble (1998-3/2000); (3) the bubble collapse (4/2000-9/2001); and (4) the pre-SOX scandal period (10/2001-7/2002). We document that abnormal accruals moved from significantly positive to significantly negative during the period of the major corporate scandals immediately preceding SOX, and remained negative in the post-SOX period. However, abnormal accruals in the post-SOX period were significantly less negative than during the scandals. Thus, a reduction (increase) in abnormal accruals (earnings quality) seems to have occurred concomitantly with the scandals, not as a result of the passage of SOX. We also document that investors' awareness of earnings manipulation by sellers consistently grew after the bursting of the technology bubble, as reflected in an increase in the discount applied to transaction prices throughout the sub-periods. Hence, concomitantly with the decrease (increase) in the levels of abnormal accruals (earnings quality) occurring during the scandals, the discount to transaction price due to suspected earnings manipulation also increased. Furthermore, the higher discount applied after SOX, relative to that immediately prior to SOX, implies that investors do not rely on SOX to prevent management from manipulating their earnings prior to a sale transaction. We conclude that changes in earnings quality prior to M&A transactions cannot be attributed to SOX. Rather, other events such as the bursting of the technology bubble and revelations of major accounting scandals seem to have affected managers' propensity to manipulate earnings. It seems that market response has a greater effect on managers' behavior than government regulation.


Corporatism and job satisfaction

Edmund Phelps & Gylfi Zoega
Journal of Comparative Economics, forthcoming

We introduce reported job satisfaction as a measure of economic performance and find it positively correlated with GDP per capita and the labor force participation rate in a sample of OECD countries and negatively correlated with unemployment. Moreover, we find that many measures of corporatism, which we define in the wider sense as institutions that hamper with the allocation of the factors of production and the distribution of income in a capitalist economy, are negatively correlated across countries with job satisfaction. Thus job satisfaction is positively correlated across countries with measures of the protection of property rights and negatively correlated with the volume of regulations of credit markets, labor markets and businesses, in addition to barriers to entrepreneurship, corruption and lack of access to capital. In contrast, measures of capitalism, such as the number of listed companies and market capitalization, are positively correlated with job satisfaction.



Tino Sanandaji & Peter Leeson
Industrial and Corporate Change, February 2013, Pages 313-337

Existing studies of entrepreneurship focus on entrepreneurs whose individual contribution to wealth creation is typically trivial: self-employed persons. This article investigates entrepreneurs whose individual contribution to wealth creation is enormous: billionaires. We explore the relationship between economic development, institutions, and these contrasting kinds of entrepreneurs. We find that the institutions consistent with self-employed entrepreneurs differ markedly from the ones consistent with billionaires. Further, only the latter are consistent with the institutions that underlie economic prosperity. Where well-protected private property rights and supporting, market-enhancing institutions flourish, so do billionaires. But self-employed entrepreneurs do not. Where private property rights are weakly protected and interventionist institutions flourish, so do self-employed entrepreneurs. But billionaires do not.


Texting Bans on Roadways: Do They Work? Or Do Drivers Just React to Announcements of Bans?

Rahi Abouk & Scott Adams
American Economic Journal: Applied Economics, forthcoming

Since 2007, many states passed laws prohibiting the use of the text messaging feature of mobile devices while driving. Using vehicular fatality data from across the United States and standard difference-in-differences techniques, bans appear moderately successful at reducing accidents among single vehicles with a single occupant following bans. This reduction is short-lived, however, with accidents returning to near former levels within a few months. This is suggestive of drivers reacting to the announcement of the legislation only to return to old habits shortly afterward.


Product Liability and Moral Hazard: Evidence from General Aviation

Eric Helland & Alexander Tabarrok
Journal of Law and Economics, August 2012, Pages 593-630

Product liability law reduces the costs of accidents to consumers, thus reducing their incentives to invest in safety. We estimate the impact of tort liability on a subset of consumers who have significant control over the probability of an accident: the consumers of general aviation aircraft. The General Aviation Revitalization Act of 1994 exempted manufacturers of small aircraft from product liability claims when their aircraft reached 18 years of age. We use the exemption at age 18 to estimate the impact of tort liability on accidents as well as on a wide variety of behaviors and safety investments by pilots and owners. The results are consistent with moral hazard. When an aircraft is exempted from tort liability, the probability that the aircraft will be involved in an accident declines. Direct evidence of pilots' and owners' behavior is also consistent with moral hazard.


Discretion and Manipulation by Experts: Evidence from a Vehicle Emissions Policy Change

Lamar Pierce & Jason Snyder
B.E. Journal of Economic Analysis & Policy, December 2012

Environmental regulation seeks to limit pollution through strict emissions thresholds for existing cars, yet it remains unclear how frequently inspectors enforce these regulations and what impact test manipulation has on policy efficacy. We demonstrate (1) that there is a distinct discontinuous drop in the distribution of emissions results at the regulatory threshold (2) that when the state tightens emissions standards, over 50% of the vehicles newly at risk for failure now pass instantaneously after the regulation changes. These improvements cannot be explained by legitimate repairs but are consistent with facilities exploiting procedural discretion in order to help consumers evade the strengthened regulations.


Does industry self-regulation reduce pollution? Responsible Care in the chemical industry

Shanti Gamper-Rabindran & Stephen Finger
Journal of Regulatory Economics, January 2013, Pages 1-30

Self-regulation programs, in which industry associations set membership codes beyond government regulations, are prevalent despite scarce evidence on their effectiveness. We examine Responsible Care (RC) in the US chemical manufacturing sub-sector, whose membership codes include pollution prevention, using our author-constructed panel database of 3,278 plants owned by 1,759 firms between 1988 and 2001. We apply two sets of instrumental variables to address a plant's parent firm's self-selection into the program, using: (i) the characteristics of other plants belonging to the same firm in our multi-plant sample; and (ii) firm participation in the industry association before the establishment of RC and industry-level RC participation in our full sample. We find that on average, plants owned by RC participating firms raise their toxicity-weighted pollution by 15.9% relative to statistically-equivalent plants owned by non-RC participating firms. This estimated increase is large relative to the yearly 4% reduction in pollution among all plants in our sample between 1988 and 2001. Moreover, RC raises plant-level pollution intensity by 15.1%. These results caution against reliance on self-regulation programs modeled on the pre-2002 RC program that did not require third party certification and in those sectors that lack independent third party certification.


What Do Revolving-Door Laws Do?

Marc Law & Cheryl Long
Journal of Law and Economics, May 2012, Pages 421-436

On the basis of evidence from state public utility commissions, we find that revolving-door laws - laws that restrict the post-government-employment opportunities of public sector workers, including public utility regulators - do not do much, at least with respect to electricity prices. In this paper, we take advantage of a quasi experiment afforded by the fact that revolving-door laws were introduced in different states at different times to investigate their effects on electricity prices. Our findings suggest that while revolving-door laws temporarily dampen industrial electricity prices, they have no effect on commercial or residential prices. There is also some evidence that these regulations affect the characteristics of state public utility commissioners; commissioners from states with revolving-door regulations serve shorter terms and are less likely to be subsequently employed in the private sector, compared with their counterparts from states without revolving-door laws.


Questioning 'law and finance': US stock market development, 1930-70

Brian Cheffins, Steven Bank & Harwell Wells
Business History, forthcoming

An important tenet of a burgeoning 'law and finance' literature is that stock market development is contingent upon corporate law offering ample protection to shareholders. This paper addresses this claim, using as its departure point developments occurring in the United States between 1930 and 1970. It shows that, contrary to what the law and finance literature would predict, during this period and throughout the twentieth century generally the US lacked corporate law that provided extensive protection to shareholders. It also points out that while federal securities legislation introduced in the mid-1930s bolstered investor protection, this reform effort did not energise the stock market in the manner implied by law and finance analysis.


Dismissal protection and small firms' hirings: Evidence from a policy reform

Stefan Bauernschuster
Small Business Economics, February 2013, Pages 293-307

Small firms are important drivers of employment creation and innovation. Dismissal protection raises firms' adjustment costs and thus reduces worker flows. In many countries, small firms are exempted from dismissal protection regulations in order to increase their flexibility. This paper exploits a shift in the firm-size threshold of the German dismissal protection law in 2004 to analyze the causal effects of relaxed dismissal protection on the hiring behavior of small firms. Using difference-in-differences techniques, we find positive effects on hirings. Placebo treatment tests based on pre-treatment periods and a fake treatment group confirm the validity of our empirical strategy.


Beyond Public and Private: Toward a Political Theory of the Corporation

David Ciepley
American Political Science Review, forthcoming

This article challenges the liberal, contractual theory of the corporation and argues for replacing it with a political theory of the corporation. Corporations are government-like in their powers, and government grants them both their external "personhood" and their internal governing authority. They are thus not simply private. Yet they are privately organized and financed and therefore not simply public. Corporations transgress all the basic dichotomies that structure liberal treatments of law, economics, and politics: public/private, government/market, privilege/equality, and status/contract. They are "franchise governments" that cannot be satisfactorily assimilated to liberalism. The liberal effort to assimilate them, treating them as contractually constituted associations of private property owners, endows them with rights they ought not have, exacerbates their irresponsibility, and compromises their principal public benefit of generating long-term growth. Instead, corporations need to be placed in a distinct category - neither public nor private, but "corporate" - to be regulated by distinct rules and norms.


Federal Directives, Local Discretion and the Majority Rule

Antoine Loeper
Quarterly Journal of Political Science, January 2013, Pages 41-74

I consider a heterogeneous federal system in which policy coordination is desirable but underprovided in the absence of a federal intervention. To improve policy coordination, the federal layer can intervene by imposing bounds on local policies. These federal bounds define a restricted policy space within which local jurisdictions have residual discretion. I analyze a voting game in which the federal bounds are determined directly by the citizens via federal majority rule. The voting equilibrium exhibits various forms of inefficiencies. When the distribution of voters' ideal policy is skewed in one direction, the federal bounds are biased in the opposite direction. When the gains from policy coordination are negligible, local discretion is too limited, and a majority of voters are worse-off with the federal intervention than without. When policy coordination is more important, the federal intervention is supported by a majority of voters, but contrary to the received wisdom, it is socially worse than no intervention. Hence, the model shows that inadequate and excessively rigid federal interventions can emerge in a democratic federation without agency costs or informational imperfections.


The economics of network neutrality

Nicholas Economides & Benjamin Hermalin
RAND Journal of Economics, Winter 2012, Pages 602-629

Under the current regime for Internet access, "network neutrality," parties are billed only by the Internet service provider (ISP) through which they connect to the Internet; pricing is not contingent on the content being transmitted. Recently, ISPs have proposed that content and applications providers pay them additional fees for accessing the ISPs' residential clients, as well as fees to prioritize certain content. We analyze the private and social implications of such fees when the network is congested and more traffic implies greater delays. We derive conditions under which network neutrality would be welfare superior to any feasible scheme for prioritizing service.


The Office of Information and Regulatory Affairs: Myths and Realities

Cass Sunstein
Harvard Law Review, forthcoming

Since its creation in 1980, the Office of Information and Regulatory Affairs (OIRA), a part of the Office of Management and Budget (OMB), has become a well-established institution within the Executive Office of the President. This essay, based on public documents and the author's experience as OIRA Administrator from 2009-2012, attempts to correct some pervasive misunderstandings and to describe OIRA's actual role. Perhaps above all, OIRA operates as an information-aggregator. One of OIRA's chief functions is to collect widely dispersed information - information that is held by those within the Executive Office of the President, relevant agencies and departments, state and local governments, and the public as a whole. Costs and benefits are important, and OIRA does focus on them (as do others within the Executive Branch, particularly the National Economic Council and the Council of Economic Advisers), above all in the case of economically significant rules. But for most rules, the analysis of costs and benefits is not the dominant issue in the OIRA process. Much of OIRA's day-to-day work is devoted to helping agencies to work through interagency concerns, promoting the receipt of public comments on a wide range of issues and options (for proposed rules), ensuring discussion and consideration of relevant alternatives, promoting consideration of public comments (for final rules), and helping to ensure resolution of questions of law, including questions of administrative procedure, by engaging relevant lawyers in the executive branch. OIRA seeks to operate as a guardian of a well-functioning administrative process, and much of what it does is closely connected to that role.


All Work and No Pay: Violations of Employment and Labor Laws in Chicago, Los Angeles and New York City

Annette Bernhardt, Michael Spiller & Diana Polson
Social Forces, forthcoming

Despite three decades of scholarship on economic restructuring in the United States, employers' violations of minimum wage, overtime and other workplace laws remain understudied. This article begins to fill the gap by presenting evidence from a large-scale, original worker survey that draws on recent advances in sampling methodology to reach vulnerable workers. Our findings suggest that in America's three largest cities, violations of employment and labor laws are pervasive across low-wage industries and occupations, affecting a wide range of workers. But while worker characteristics are correlated with violations, job and employer characteristics play the stronger role, including industry, occupation and measures of informality and nonstandard work. We therefore propose a framework in which employers' noncompliance with labor regulations is one axis of a competitive strategy based on labor cost reduction, contributing to the reorganization of work and production in the 21st century labor market.


Prudence as a competitive advantage: On the effects of competition on banks' risk-taking incentives

Roman Inderst
European Economic Review, forthcoming

This paper builds on the notion that corporate borrowers care about the overall riskiness of a bank's operations as their continued access to credit may depend on the bank's ability to roll over loans or to expand existing credit facilities. A key implication of this observation is that increasing competition among banks should have an asymmetric impact on banks' incentives to take on risk: Banks that are already riskier will take on yet more risk, while their safer rivals will become even more prudent.


How firms respond to mandatory information disclosure

Anil Doshi, Glen Dowell & Michael Toffel
Strategic Management Journal, forthcoming

Mandatory information disclosure regulations seek to create institutional pressure to spur performance improvement. By examining how organizational characteristics moderate establishments' responses to a prominent environmental information disclosure program, we provide among the first empirical evidence characterizing heterogeneous responses by those mandated to disclose information. We find particularly rapid improvement among establishments located close to their headquarters and among establishments with proximate siblings, especially when the proximate siblings are in the same industry. Large establishments improve more slowly than small establishments in sparse regions, but both groups improve similarly in dense regions, suggesting that density mitigates the power of large establishments to resist institutional pressures. Finally, privately held firms' establishments outperform those owned by public firms. We highlight implications for institutional theory, managers, and policymakers.


What Drives Taxi Drivers? A Field Experiment on Fraud in a Market for Credence Goods

Loukas Balafoutas et al.
Review of Economic Studies, forthcoming

Credence goods are characterized by informational asymmetries between sellers and consumers that invite fraudulent behavior by sellers. This paper presents a natural field experiment on taxi rides in Athens, Greece, set up to measure different types of fraud and to examine the influence of passengers' presumed information and income on the extent of fraud. We find that passengers with inferior information about optimal routes are taken on detours of almost double length, while lack of information on the local tariff system increases the likelihood of manipulated bills by about fifteen percentage-points. Passengers' income seems to have no effect on fraud.

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