Public and Private Enforcement of Securities Laws

This post is by Mark Roe of Harvard Law School.

Public and Private Enforcement of Securities Laws: Resource-Based Evidence, which Howell Jackson and I just revised, is in the pipeline for publication in the Journal of Financial Economics. (We posted an earlier version of Enforcement to this Forum (available here) about a year ago after we presented it at the Law and Economics Seminar here at the Law School.) This post focuses on the updates and changes we have made to the paper during the subsequent year.

The central thesis remains as before: Although recent academic work in finance finds private investor protection more important in determining the depth and breadth of financial markets than public enforcement via financial, regulatory, and even criminal rules and penalties, we do not find evidence supporting that kind of relationship. As before, our measure of public enforcement intensity turns on the resources of securities regulators around the world, focusing on their staffing and their budget levels. In the revised paper, we measure these levels across multiple sample constructions, test for influential observations, and examine whether corruption levels in the poorer nations drive our results. In each robustness check, our results — a significant coefficient on the level of public enforcement — persists for financial outcomes such as the size of a nation’s securities market, the number of domestic firms, trading volume, and the number IPOs in the nation.

We cannot fully unpack causation issues, which persist, as they do in the prior work on private enforcement. This is partly because of data limits — we have extensive budget and staffing data for recent years, but not over an extended time period. But the results now indicate quite clearly that the rejection of the viability of public enforcement in the prior literature and by some units in the international development agencies, such as the World Bank, is not supported by the best measures of public enforcement intensity. The difference between our results and the prior results in the literature is largely due to a sharp difference in the research design for measuring public enforcement intensity. In prior work, it was measured via formal levels of authority of the securities regulator. We now show why these formal measures are unlikely to measure public enforcement as well as the regulators’ resources. A formally-empowered regulator without a good budget and a good staff cannot do much; conversely a well-endowed regulator with spotty formal authority can still achieve much in the way of enforcement. We now show that our measures do not correlate with the prior, more formal measures and we explain why we see our measures as better measures of the intensity of public enforcement.

Our revised results also yield insight into which aspects of private enforcement are important to robust capital markets and which are not. While good disclosure is consistently associated with robust capital markets, private litigation liability indices are not, particularly once one controls for the level of resources dedicated to public enforcement. They are often insignificant, often with coefficients having the “wrong” sign. These results comport with a consensus picture among legal scholars of a deficient system of private securities litigation in the United States: It’s poorly designed, with firms, and hence wronged shareholders, often bearing the cost of insiders’ errors and disclosure failure. Wrongdoers frequently do not pay for their wrongs; innocent shareholders often do. Hence, there’s some a priori reason, consistent with our regression results, to be wary of private litigation as the major mechanism for securities law enforcement in developing, and maintaining, good financial markets.

The full paper is available for download here.

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