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

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  • Katharina Pistor
  • Chenggang Xu
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    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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    File URL: http://sticerd.lse.ac.uk/dps/te/te442.pdf
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    Bibliographic Info

    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
    Date of revision:
    Handle: RePEc:cep:stitep:442

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    Web page: http://sticerd.lse.ac.uk/_new/publications/default.asp

    Related research

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

    This paper has been announced in the following NEP Reports:

    References

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    1. Rafael LaPorta & Florencio Lopez de-Silanes & Andrei Shleifer & Robert W. Vishny, 1996. "Law and Finance," Harvard Institute of Economic Research Working Papers 1768, Harvard - Institute of Economic Research.
      • 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.
      • La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert W., 1998. "Law and Finance," Scholarly Articles 3451310, Harvard University Department of Economics.
    2. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
    3. Rafael Porta & Florencio Lopez-De-Silanes & Andrei Shleifer, 2006. "What Works in Securities Laws?," Journal of Finance, American Finance Association, vol. 61(1), pages 1-32, 02.
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    6. Edward L. Glaeser & Andrei Shleifer, 2001. "The Rise of the Regulatory State," NBER Working Papers 8650, National Bureau of Economic Research, Inc.
    7. Priest, George L, 1993. "The Origins of Utility Regulation and the "Theories of Regulation" Debate," Journal of Law and Economics, University of Chicago Press, vol. 36(1), pages 289-323, April.
    8. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
    9. Gary S. Becker, 1974. "Crime and Punishment: An Economic Approach," NBER Chapters, in: Essays in the Economics of Crime and Punishment, pages 1-54 National Bureau of Economic Research, Inc.
    10. 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.
    11. 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.
    12. 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.
    13. 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.
    14. Richard A. Posner, 1974. "Theories of Economic Regulation," NBER Working Papers 0041, National Bureau of Economic Research, Inc.
    15. 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.
    16. Laffont, Jean-Jacques, 1994. "The New Economics of Regulation Ten Years After," Econometrica, Econometric Society, vol. 62(3), pages 507-37, May.
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    Cited by:
    1. Rafael Porta & Florencio Lopez-De-Silanes & Andrei Shleifer, 2006. "What Works in Securities Laws?," Journal of Finance, American Finance Association, vol. 61(1), pages 1-32, 02.
    2. 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.
    3. 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.
    4. Thorsten Beck & Ross Levine, 2003. "Legal Institutions and Financial Development," NBER Working Papers 10126, National Bureau of Economic Research, Inc.
    5. Hokky Situngkir, 2004. "The Structural Dynamics of Corruption: Artificial Society Approach," Computational Economics 0405002, EconWPA.
    6. Lopez-de-Silanes, Florencio, 2004. "A survey of securities laws and enforcement," Policy Research Working Paper Series 3405, The World Bank.

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