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Law Enforcement under Incomplete Law: Theory and Evidence from Financial Market Regulation

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Author Info
Katharina Pistor
Chenggang Xu
Abstract

This paper studies the design of law-making and law enforcement institutions based on the premise that law is inherently incomplete. Under incomplete law, law enforcement by courts may suffer from deterrence failure, defined as the social-welfare loss that results from the regime's inability to deter harmful actions. As a potential remedy a regulatory regime is introduced. The major functional difference between courts and regulators is that courts enforce law reactively, that is only once others have initiated law enforcement procedures, while regulators enforce law proactively, i.e. on their own initiative. Proactive law enforcement may be superior in preventing harm. However, it incurs high costs and may err in stopping potentially beneficial activities. We study optimal regime selection between a court and a regulatory regime and present evidence from the history of financial market regulation.

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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Theoretical Economics Paper Series with number 442.

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Date of creation: Dec 2002
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Handle: RePEc:cep:stitep:442

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Keywords: Incomplete law; law enforcement; financial market; regulation.;

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  1. A. Mitchell Polinsky & Steven Shavell, 2000. "The Economic Theory of Public Enforcement of Law," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 45-76, March. [Downloadable!] (restricted)
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  2. Mookherjee, Dilip & Png, I P L, 1992. "Monitoring vis-a-vis Investigation in Enforcement of Law," American Economic Review, American Economic Association, vol. 82(3), pages 556-65, June. [Downloadable!] (restricted)
  3. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Blackwell Publishing, vol. 66(1), pages 115-38, January. [Downloadable!] (restricted)
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  4. Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer & Robert W. Vishny, 1996. "Law and Finance," NBER Working Papers 5661, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Richard A. Posner, 1974. "Theories of Economic Regulation," NBER Working Papers 0041, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer, 2003. "What Works in Securities Law?," NBER Working Papers 9882, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Priest, George L, 1993. "The Origins of Utility Regulation and the "Theories of Regulation" Debate," Journal of Law & Economics, University of Chicago Press, vol. 36(1), pages 289-323, April.
  8. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August. [Downloadable!] (restricted)
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  9. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Blackwell Publishing, vol. 66(1), pages 83-114, January. [Downloadable!] (restricted)
  10. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, vol. 76, pages 169. [Downloadable!] (restricted)
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  11. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August. [Downloadable!] (restricted)
  12. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  13. Laffont, Jean-Jacques, 1994. "The New Economics of Regulation Ten Years After," Econometrica, Econometric Society, vol. 62(3), pages 507-37, May. [Downloadable!] (restricted)
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  14. Stigler, George J, 1970. "The Optimum Enforcement of Laws," Journal of Political Economy, University of Chicago Press, vol. 78(3), pages 526-36, May-June. [Downloadable!] (restricted)
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  15. Edward L. Glaeser & Andrei Shleifer, 2003. "The Rise of the Regulatory State," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 401-425, June.
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  16. Victor P. Goldberg, 1976. "Regulation and Administered Contracts," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 426-448, Autumn. [Downloadable!] (restricted)
  17. Romer, Christina D, 1990. "The Great Crash and the Onset of the Great Depression," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 597-624, August. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Simeon Djankov & Edward L. Glaeser & Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer, 2003. "The New Comparative Economics," NBER Working Papers 9608, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Thorsten Beck & Ross Levine, 2003. "Legal Institutions and Financial Development," NBER Working Papers 10126, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Hokky Situngkir, 2004. "The Structural Dynamics of Corruption: Artificial Society Approach," Computational Economics 0405002, EconWPA. [Downloadable!]
  4. Lopez-de-Silanes, Florencio, 2004. "A survey of securities laws and enforcement," Policy Research Working Paper Series 3405, The World Bank. [Downloadable!]
  5. Julian Franks & Colin Mayer & Stefano Rossi, 2003. "Ownership: Evolution and Regulation," OFRC Working Papers Series 2003fe14, Oxford Financial Research Centre. [Downloadable!]
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  6. Tong, Jian & Xu, Chenggang, 2003. "Financial Institutions and the Wealth of Nations: Tales of Development," Discussion Paper Series In Economics And Econometrics 0404, Economics Division, School of Social Sciences, University of Southampton. [Downloadable!]
    Other versions:
  7. Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer, 2003. "What Works in Securities Law?," NBER Working Papers 9882, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
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