Public Enforcement of Securities Laws: Preliminary Evidence

Abstract

The consequence of economic actors ignoring their legal obligations, such as laws that protect outside investors in firms, is a recurring issue. Recent work in finance examines the relative importance for investor protection of private enforcement on the one hand―via disclosure and lawsuits among contracting parties―and public enforcement on the other―via financial, regulatory and even criminal rules and penalties. Much legal scholarship has seen private enforcement of securities laws as poorly designed, with firms—and hence wronged shareholders—-often bearing the cost of insiders’ errors and disclosure failure. To better investigate the importance of public and private enforcement, we here develop an enforcement variable based on the securities regulators’ staffing levels and budgets. We then examine financial outcomes around the world―such as stock market capitalization, trading volumes and number of domestic firms and IPOs―in light of these measures of public enforcement and find that more intense public enforcement regularly correlates with strong financial outcomes. Moreover, in horse races between our measures of public enforcement and the usual measures of private enforcement, public enforcement is typically at least as important as private enforcement in explaining important financial market outcomes around the world. Hence, we caution against using the current explanations that rely on the strength of private enforcement to the exclusion of public enforcement in making public policy around the world. We conclude by speculating why public enforcement may well prove to be as, or more, important than private enforcement in explaining world-wide financial outcomes. Public Enforcement of Securities Law: Preliminary Evidence Howell E. Jackson & Mark J. Roe Introduction 1 I. Public and Private Enforcement? 4 A. Private Remedies 4 B. Public Enforcement 6 C. Measuring Public Enforcement: Staffing and Budgets 7 II. Results 12 A. Public Enforcement and Market Size 12 B Prior Public Enforcement Measures 14 C Limitations to Prior Public Enforcement Indices 15 D. Staffing and Budgets vs. Prior Public Enforcement Measures 16 E. Financial Variables Associated with Dispersed Ownership 18 F. Limits to Both Private and Public Enforcement: Intermediate Financial Variables 21 G. The Direction of Causality? 22 H. Legal Origin and Regulatory Intensity 23 III. Discussion 25 A. Channels from Public Enforcement to Financial Outcomes 25 B. The Potential Importance of Public Enforcement 26 C. Developing Better Measures of Public Enforcement 27 D. Public Enforcement and Private Enforcement 28 Conclusion 28 Figure 1: Securities Regulators per Million of Population 32 Figure 2: Securities Budgets per Billion of U.S. Dollars of GDP 32 Figure 3: Civil versus Common Law Staffing 33 Figure 4: Civil versus Common Law Budgets 33 Table 1: Securities Enforcement Variables 10 Table 2: Summary Statistics on Public Enforcement Variables 11 Table 3: Pair-wise Correlation Matrix for Key Variables 12 Table 4: New Enforcement Variables and the Size of Capital Markets 13 Table 5: Reformulation of LLS Regressions on Public Enforcement 17 Table 6: Reformulation of Other LLS Regressions 18 Table 9: Regressions with LLS Dependent Variables Associated with Private Control 20 Table 10: Regressions with New World Bank Indices as Dependent Variables 21 Table 7: Public Enforcement and Common Law Origins 23 Table 8: Nested Regressions: Dependent Variable as 2004 Market Capitalization to GDP 25 Public Enforcement of Securities Laws: Preliminary Evidence Howell E. Jackson & Mark J. Roe

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