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Law enforcement under incomplete law: theory and evidence from financial market regulation

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  • Katharina Pistor
  • Cheng-Gang 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://eprints.lse.ac.uk/3748/
    File Function: Open access version.
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    Bibliographic Info

    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 3748.

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    Length: 46 pages
    Date of creation: Dec 2002
    Date of revision:
    Handle: RePEc:ehl:lserod:3748

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    Web page: http://www.lse.ac.uk/
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    Related research

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

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    References

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    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.:
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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. Richard A. Posner, 1974. "Theories of Economic Regulation," NBER Working Papers 0041, National Bureau of Economic Research, Inc.
    3. 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.
    4. Gary S. Becker, 1968. "Crime and Punishment: An Economic Approach," Journal of Political Economy, University of Chicago Press, vol. 76, pages 169.
    5. 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 LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, . "Law and Finance," Working Paper 19451, Harvard University OpenScholar.
      • La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert W., 1998. "Law and Finance," Scholarly Articles 3451310, Harvard University Department of Economics.
      • 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.
    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. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
    8. Christina D. Romer, 1988. "The Great Crash and the Onset of the Great Depression," NBER Working Papers 2639, National Bureau of Economic Research, Inc.
    9. George J. Stigler, 1971. "The Theory of Economic Regulation," Bell Journal of Economics, The RAND Corporation, vol. 2(1), pages 3-21, Spring.
    10. A. Mitchell Polinsky & Steven Shavell, 1999. "The Economic Theory of Public Enforcement of Law," NBER Working Papers 6993, National Bureau of Economic Research, Inc.
    11. 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.
    12. 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.
    13. Victor P. Goldberg, 1976. "Regulation and Administered Contracts," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 426-448, Autumn.
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    Cited by:
    1. Djankov, Simeon & Glaeser, Edward L & López-de-Silanes, Florencio & Shleifer, Andrei, 2003. "The New Comparative Economics," CEPR Discussion Papers 3882, C.E.P.R. Discussion Papers.
    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. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer, . "What Works in Securities Laws?," Working Paper 19491, Harvard University OpenScholar.
    4. Lopez-de-Silanes, Florencio, 2004. "A survey of securities laws and enforcement," Policy Research Working Paper Series 3405, The World Bank.
    5. Hokky Situngkir, 2004. "The Structural Dynamics of Corruption: Artificial Society Approach," Computational Economics 0405002, EconWPA.

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