On the Effects of Capital Markets’ Regulation on Allocation Efficiency: An Assessment of EU Market Abuse Directive

Abstract

This study investigates the impact of Market Abuse Directive (MAD) adoption by EU countries on capital market allocation efficiency. Three dimensions of allocation efficiency are examined: investment-Q sensitivity, the link between investment rates and future profitability, and stock price informativeness in terms of firm profitability. Impact of MAD adoption on these dimensions of allocation efficiency is examined through the lens of panel data models and a difference-in-differences analysis. Overall, empirical results cast serious doubts on the merits of MAD adoption on these dimensions of allocation efficiency. As to investment-Q sensitivity and the ability of current investment rates to explain future profitability, the impact was neutral to slightly negative. More significantly, our findings indicate a decline of the information content of stock prices about future firm profitability in the aftermath of MAD entry-into-force. Interestingly, the impact was more detrimental in countries that adopted MAD without ensuring suitable supervisory powers to national regulators. Effects were less pronounced in countries lacking regulatory quality, rule of law, and government effectiveness.