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

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  • Pistor, Katharina
  • Xu, Cheng-Gang

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.

Suggested Citation

  • Pistor, Katharina & Xu, Cheng-Gang, 2002. "Law enforcement under incomplete law: theory and evidence from financial market regulation," LSE Research Online Documents on Economics 3748, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:3748
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    File URL: http://eprints.lse.ac.uk/3748/
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    References listed on IDEAS

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    5. Oliver Hart & John Moore, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 115-138.
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    7. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 83-114.
    8. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1113-1155, December.
    9. 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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    Citations

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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, February.
    2. Luc Laeven, 2014. "The Development of Local Capital Markets; Rationale and Challenges," IMF Working Papers 14/234, International Monetary Fund.
    3. Djankov, Simeon & Glaeser, Edward & La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei, 2003. "The new comparative economics," Journal of Comparative Economics, Elsevier, vol. 31(4), pages 595-619, December.
    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.
    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.

    More about this item

    Keywords

    Incomplete law; law enforcement; financial market; regulation;

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • K4 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior
    • N2 - Economic History - - Financial Markets and Institutions
    • K2 - Law and Economics - - Regulation and Business Law

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