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

  • Katharina Pistor
  • Chenggang Xu

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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  8. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
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  10. Steven Shavell & A. Mitchell Polinsky, 2000. "The Economic Theory of Public Enforcement of Law," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 45-76, March.
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  15. 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.
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