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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 socialwelfare 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://repec.org/esFEAM04/up.12015.1084367224.pdf
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    Bibliographic Info

    Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 791.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:feam04:791

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

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    1. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," NBER Working Papers 6726, National Bureau of Economic Research, Inc.
    2. 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.
    3. A. Mitchell Polinsky & Steven Shavell, 1999. "The Economic Theory of Public Enforcement of Law," NBER Working Papers 6993, National Bureau of Economic Research, Inc.
    4. 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.
    5. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, vol. 76, pages 169.
    6. 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.
    7. 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.
    8. 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.
    9. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert W., 1998. "Law and Finance," Scholarly Articles 3451310, Harvard University Department of Economics.
    10. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
    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.
    12. Laffont, Jean-Jacques, 1994. "The New Economics of Regulation Ten Years After," Econometrica, Econometric Society, vol. 62(3), pages 507-37, May.
    13. Richard A. Posner, 1974. "Theories of Economic Regulation," Bell Journal of Economics, The RAND Corporation, vol. 5(2), pages 335-358, Autumn.
    14. Christina D. Romer, 1988. "The Great Crash and the Onset of the Great Depression," NBER Working Papers 2639, National Bureau of Economic Research, Inc.
    15. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
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