Abstract
Ascertaining which enforcement mechanisms work to protect investors has been both a focus of recent work in academic finance and an issue for policy-making at international development agencies. According to recent academic work, private enforcement of investor protection via both disclosure and private liability rules goes hand in hand with financial market development, but public enforcement fails to correlate with financial development and, hence, is unlikely to facilitate it. Our results confirm the disclosure result but reverse the results on both liability standards and public enforcement. We use securities regulators’ resources to proxy for regulatory intensity of the securities regulator. When we do, financial depth regularly, significantly, and robustly correlates with stronger public enforcement. In horse races between these resource-based measures of public enforcement intensity and the most common measures of private enforcement, public enforcement is overall as important as disclosure in explaining financial market outcomes around the world and more important than private liability rules. Hence, policymakers who reject public enforcement as useful for financial market development are ignoring the best currently available evidence.
Highlights
We evaluate the value of public enforcement of securities law for the development of stock markets around the world
Our basic research pattern is first to replicate prior analyses of public enforcement from La Porta et al (2006), substitute our new resource–based measures of public enforcement for the prior enforcement indices, and check for robustness, including robustness when controlling for private enforcement
The resource–based indicators are consistently as strongly associated with robust capital markets as the best performing index of private enforcement and substantially more strongly associated with robust capital markets than several other indices of private enforcement, including liability rules and anti–director rights
Summary
We evaluate the value of public enforcement of securities law for the development of stock markets around the world. The World Bank, for example, in seeking to strengthen financial markets and propel economic growth, has recently dismissed public enforcement of securities laws as being unimportant, while seeing private enforcement as central, conclusions we see as having been reached too hastily. Our results indicate that their analyses underestimate the extent to which robust public enforcement is associated with capital market development. In principle, both enforcement mechanisms could have serious defects and strong advantages. Public enforcement could be run by public–regarding policymakers and invoke sharp criminal, financial, and reputational penalties that deter egregious wrongdoing, while private enforcement actions could be brought by well–informed actors with well–aligned incentives
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