Capital Market Regulation Research Articles

The Keynote Papers and the Current Financial Crisis

One hesitates to write history as it happens, or to draw policy lessons from current events. The conference took place in May 2008 - after the government-assisted takeover of Bear Stearns but before a capital market downturn fueled a system-wide liquidity crisis, with successive insolvencies at IndyMac, Fannie Mae, Freddie Mac, Lehman, AIG, WaMu, and, as I write, Citigroup. But it would be odd to comment on capital market regulation without mentioning the events of the last three months. I am first to acknowledge that anything I might have written in May would not have foreseen the crisis or linked capital market regulation to financial institutions, which in the US have been conventionally treated as discrete in discourse and institutions (e.g., U.S. Treasury 2008; Leuz and Wysocki 2008).

Recent SEC initiatives that should enhance access to the US capital markets by foreign private issuers

In recent years, non-US companies have been increasingly reluctant to list or publicly offer securities in the United States. According to the Committee on Capital Markets Regulation, in 1996, 45 per cent of global initial public offerings (IPOs)1 completed by non-US companies were listed on a US exchange. In the first nine months of 2007, this number fell to 10 per cent.2 A major factor contributing to this trend is the perceived legal and regulatory burden that accompanies a listing or public offering of securities in the United States.3 Evidence of this concern is the trend of non-US companies to raise capital in the United States by means of private placements in reliance on SEC Rule 144A rather than by public securities offerings registered with the SEC. Non-US companies that access the US capital markets only through Rule 144A offerings are exempt from the SEC disclosure...

Kapitalmarktregulierung. Eine Untersuchung über Konzeption und Dogmatik des Regulierungsverwaltungsrechts

The goal of this article is twofold. Firstly, it displays capital market law as an instructive reference point within administrative law. To this end, it describes the fundamentals of this field of law by identifying the characteristics of capital markets and the objectives and structural peculiarities of capital market law. Secondly, this article aspires to contribute to the development of the administrative regulatory environment. The scope of this field of law should not be restricted to the classic field of network infrastructure regulation but should increasingly extend into all areas in which the state – oriented towards market mechanisms – stimulates, structures, supports, and protects markets. Capital market regulation occupies a unique position within administrative law. It essentially consists of two regulatory systems, one providing for supervisory powers and the other imposing duties on market participants to disclose and explain.

Corporate governance and performance of Nigerian listed firms: Further evidence

This work, in an agency framework, adds to the few literatures on Nigeria by examining the impact of corporate governance on firm financial performance. Using a sample of 64 listed non-financial firms for the period 2002 to 2006, the study is able to capture the impact of the New Code of Corporate Governance released in 2003 on previous findings. Introductory investigations on the Nigerian capital market operations and regulations depict low, but improving, states. Empirically, Panel regression estimates show that board size, audit committee independence and ownership concentration aid performance. Higher independent directors and directors’ portion of shares unexpectedly dampen performance, while firms vesting both the roles of CEOs and chairs in the same individual perform better.

Statement of the Financial Economists Roundtable on the International Competitiveness of U.S. Capital Markets

The Committee on Capital Markets Regulation issued an Interim Report (known as the “Paulson Report”) near the end of 2006 that concluded that the U.S. “is losing its leading competitive position as compared to stock markets and financial centers abroad.” This report was quickly followed by a study, which reached similar conclusions, that was commissioned by New York Mayor Michael Bloomberg and Senator Charles Schumer and prepared by McKinsey & Co.At its July 2007 annual meeting, the Financial Economists Roundtable (FER) — a group of senior financial economists at universities and other organizations recognized as having made significant contributions to the finance literature—discussed the issues raised by the Report and decided to publish its own report. The report makes the following four policy recommendations: Securities class action suits —Abolish enterprise liability under rule 10b‐5 in situations arising out of security purchases and sales in the secondary trading market among outside shareholders, while retaining managerial and firm liability where the company itself or its insiders (officers and directors) transact to their own benefit. Imposing massive liability on a company that is not a party to the securities transactions and does not benefit from the fraud does not serve a deterrence function since it is the continuing shareholders of the corporation who bear the burden of what the company must pay if found guilty, either directly or indirectly through insurance premiums. Shareholder rights—Require all corporations to obtain shareholder approval to adopt a poison pill, regardless of whether a company has a staggered board. This requirement would conform to the broad principle that the board of any company should not be able to deny its shareholders the opportunity to decide on the merits of a takeover bid, and it would help restore the market for corporate control as an effective disciplinary mechanism for poorly performing boards and managers. Compliance costs associated with SOX §404—Adopt a statutory amendment that makes it optional for a company to adopt the §404 procedures for a management assessment and auditor attestation of the effectiveness of its internal controls, with the requirement that if the company chooses not to comply it must explain why in its financial statements. Thus, in effect, the FER effectively recommends that the market be allowed to determine the value of §404 compliance. If a company chooses not to comply, the market will assess its explanation for non‐compliance and will value the company accordingly. Maintaining open markets—Allow both foreign and U.S. firms to choose to report in conformity with either IFRS or U.S. GAAP. The FER recognizes both IFRS and U.S. GAAP as high‐quality accounting standards that provide reasonable foundations for financial reporting for investors. Allowing both foreign and U.S. firms to adopt whichever of these standards they believe to be the most cost‐effective provides an opportunity for the market and investors themselves to sort out which reporting standard best serves their interests.

A Survey Study of Board Practices at Large Firms in Egypt

Good corporate governance is essential for companies in reaching their full competitive potential in the global marketplace with unimpeded access to capital for their growth. During the recent years, Egypt has embraced a reform agenda that resulted in significant economic growth and substantial increase in foreign direct investment attracted into the country, with large gains for investors in the Cairo and Alexandria Stock Exchange, the CASE. This growth has drawn special attention to the corporate governance practices by listed companies, and particularly disclosure and implementation of international standards for accounting and auditing. Boards are vital in improving company performance and ensuring fair treatment for all shareholders. To fulfill their role, boards must be both able and willing to exercise objective and independent judgment so that all publicly held companies disclose adequate information to shareholders about how their boards work and to fully implement the board structures and practices. The Egyptian Code of Corporate Governance was published in 2005 to provide guidance for all corporates in Egypt. The purpose of this first survey of Egyptian corporate boards is to analyze compliance with the Code relative to the general board practices among the top 30 companies traded in CASE. Secondly, to seek possible ways in which good corporate governance may further improve the overall business and investment environment in Egypt. The survey looks at (a) the composition of the boards of directors; (b) the committee structures; (c) disclosure and transparency practices; and, (d) the board control environment. Preliminary indicators show that Egyptian boards score high on some of the key elements of effective boards. Other elements, however, still need considerable improvements if those boards are to become more effective in implementing good corporate governance. Overall, large Egyptian firms represented by the top 30 CASE listed companies have some clear strengths but still face challenges in catching up with the global best practices, while striving to reach full, voluntary compliance with the Egyptian Code of Corporate Governance of 2005. The survey also provides policy implications for Egyptian capital market regulators and offers guidance to investors in the largest listed Egyptian companies to demand improvements from their boards. Additionally, the paper will help in development and the implementation of market relevant board practices.

Protecting investors and the integrity of capital markets

PurposeThe aim of this paper is to express a point of view concerning recent recommendations to reduce or eliminate the authority of state securities regulators.Design/methodology/approachThe paper cites three recent reports by the Committee on Capital Markets Regulation, McKinsey & Co., and the US Chamber of Commerce and makes a case for a continued, strong role of state securities regulators, working alongside federal and SRO regulators.FindingsThe study contends that the cited reports reach the wrong conclusions concerning US capital markets competitiveness and the need to weaken the securities regulatory framework.Originality/valueThe paper expresses a state securities regulator's point of view and provides the reader with web site references for three important recent reports in US capital markets competitiveness.

The role of capital market in determining capital structure: Evidence from Slovenian public and private corporations

This article tests the role the Slovenian capital market plays in determining corporate capital structure. It concludes that even though private corporations exhibit higher relative debt levels than their public counterparts, their dynamics are governed in similar ways. One potential reason for that is the country’s poorly developed primary capital market, which creates similar external barriers to raising capital. The article highlights factors that cause this situation and provides guidelines for capital market regulators in (post-)transition economies about related issues to address. This facilitates the design of financial systems and legal environments in a way that helps create a well-functioning primary capital market, i.e. a cost-efficient mechanism to raise new financial sources and to help achieve the efficient allocation of funds in the economy.

Alternative Methods of Convergence Toward U.S. Market and Legal Regulations: Cross-Listing vs. Merging with U.S. Bidders

Non-U.S. firms have two options to converge toward U.S. capital market and legal regulations - to cross-list in the U.S. or to agree to be acquired by a U.S. bidder. We show that companies that have lower growth opportunities, are more capital intensive, and seek bonding benefits through compliance with U.S. exchange (rather than OTC market) requirements are more likely to be acquired, and that firms from civil law countries tend to cross-list. We document that the adoption of Sarbanes-Oxley Act of 2002 (SOX) led to an increase in the propensity to be acquired for firms from civil law countries, and to a greater rate of cross-listings for capital intensive firms from common law countries and for firms from countries with strong protection of investor rights. We also show that Market-to-Book values of non-U.S. firms following cross-listing in the U.S. tend to be lower when these firms were expected to be acquired. Similarly, both non-U.S. targets and U.S. bidders experience lower abnormal returns in acquisitions involving targets expected to cross-list. Our results imply the existence of optimal convergence choices of non-U.S. firms. In addition, the adoption of SOX appears to have changed some determinants of these choices due to shift in benefits and costs of compliance with U.S. regulations.

Investment Patterns of Informal Investors in the Alberta Private Equity Market*

This study identifies three main types of informal investors in private equity markets: relationship investors, opportunity‐based investors, and angel investors. We find evidence that the first two investor types are a major total source of capital and they prefer to invest smaller amounts close to home and in the context of existing relationships. With respect to angel investors, we find evidence of stratification in their desired investment amount which is consistent with a model where their investments evolve though a life cycle of investing. We also find evidence that changes to capital market regulations that allow for lower investment amounts by this type of investor increase the amount of capital available for early‐stage firms.

Governance structures, ethnicity, and audit fees of Malaysian listed firms

PurposeThe purpose of this study is to examine the association between external audit fees, and board and audit committee characteristics of 736 Malaysian listed firms. It is hypothesised that good corporate governance practices reduce auditors' risk assessments, resulting in lower audit fees. Drawing on the existence of a clearly identifiable ethnic domination of board membership and ownership of Malaysian listed firms, the study also posits that Bumiputera‐controlled firms pay higher audit fees because of their weaker governance practices.Design/methodology/approachThis study employs a cross‐sectional analysis of 736 firms listed on the Bursa Malaysia for the financial year ending in 2003. Multiple regression analysis is used to estimate the relationships proposed in the hypotheses.FindingsOverall, the results of this study reveal that external audit fees are positively and significantly related to board independence, audit committee expertise, and the frequency of audit committee meetings. The study also finds a strong negative association between external audit fees and Bumiputera‐owned firms. An additional analysis into the internal governance structures of firms in the sample show that Bumiputera firms practice more favourable corporate governance practices compared to their non‐Bumiputera counterparts.Originality/valueThis study is a unique contribution in that it provides data on corporate governance practices in Malaysia for a large sample in the period after the corporate governance reforms taken by Malaysian capital market regulators and participants. Previous studies have shown that Bumiputera‐controlled firms pay higher audit fees than non‐Bumiputera‐controlled firms. These studies have not tested theoretical explanations for this fee differential. A theoretical explanation provided in the current study is that Bumiputera‐controlled firms pay higher audit fees than non‐Bumiputera‐controlled firms partially because of differences in corporate governance practices. The study finds conflicting results with previous research suggesting that corporate governance practices have changed in Malaysia since the amendments of Bursa Malaysia Listing Requirements, 2001.

Reforming provident and pension fund regulation in India

PurposeTo examine the case for reforming India's current provident and pension fund governance and regulatory structures.Design/methodology/approachThe paper reviews various components of India's social security system with a view to identifying reform needs in their governance and regulatory structures. It then assesses the new pension system to be supervised and regulated by the proposed Pension Fund Regulatory and Development Authority (PFRDA).FindingsThe paper finds that the current arrangements do not provide sufficient incentives for professionalism and system‐wide perspective essential to meet India's social security challenges. Urgently operationalizing the PFRDA, and modernizing the relevant laws and regulations could greatly assist in meeting India's social security challenges. Modernization of Employees Provident Fund Organization is also essential.Research limitations/implicationsThe analysis suggests that the need for greater professionalism and system‐wide perspective should be accorded high priority by India's provident and pension fund organizations. The analysis in the paper is quite aggregative and qualitative. This underscores the need for more robust database and greater focus on empirical evidence‐based policies in this area.Originality/valueThe paper will provide a better appreciation of the governance and regulatory issues involved in reforming India's provident and pension funds. It will also provide a base for other researchers to identify and undertake more detailed analysis of specific aspects such as ways to internationally benchmark administration and compliance costs of provident and pension fund organizations; achieving coordination among PFRDA, banking, insurance, and capital market regulators.

Explaining cosmetic compliance with international regulatory regimes: The implementation of the Basle Accord in Japan, 1998–2003

A central theme of much recent international political economy (IPE) scholarship has been the question of what determines compliance with international regulatory regimes.1 The contemporary debate ...

The Efficient Capital Market Hypothesis Revisited: Implications of the Economic Model for the United States Regulator

Most capital market regulation is expressly or implicitly based on a theory of how the regulated market works. That is, the regulation requires actor A to take action X or prohibits A from taking action Y—all with the purpose of getting the market to do M or preventing the market from doing N. Such regulation rests, explicitly or by implication, on some theory that connects the actions X or Y—by actor A—with market reactions M and N. In the United States, the Efficient Capital Market Hypothesis is the basis for most regulation. The behavioral finance’s approach can be integrated into the same framework of law and economics, of which it constitutes an improvement capable of explaining the failure of the EMCH in some marginal cases. Except in short periods like the high-tech bubble, however, behavioral finance may only explain the actions of certain investors, such as individuals, and not the actions of the market as a whole. In the United States, arbitrageurs will overcome psychologically based trading in most cases. The Efficient Capital Market Hypothesis is an economic model, which assumes that the market is comprised of a large number of rational participants and that information is fully and quickly available to them. In the U.S. and the U.K., the elements of an efficient market can generally be traced. In turn, information is provided to the market by corporate insiders. Thus, a risk exists that it be limited, inaccurate, or fraudulent. As a general matter, “corporate governance” refers to an important legal relationship that exists between managers, auditors and the board of directors. In the United States, the company’s management governs the company under the supervision of the board of directors and for the benefit of its shareholders. Auditors ensure that the management complies with accounting standards, thereby providing shareholders and prospective investors with an accurate understanding of the company’s financial health. Two factors played an important role in leading to the corporate scandals of the early 2000’s: a) auditors’ misperception that their responsibilities was to serve the management, and b) the need for CEOs and CFOs to ensure that financial information (particularly referred to quarterly and annually financial disclosures) be accurate. This paper argues that the ECMH still provides (some 40 years after its widespread dissemination) the theory of how markets work, which is the most useful theory for regulators in the United States.

Inefficiency and Path Dependency in Canada's Securities Regulatory System: Towards a Reform Agenda

We analyze the claim that Canadian capital markets are inefficient and examine reform proposals in light of this claim. We argue on the basis of empirical evidence that the Canadian securities regime is burdened by four types of cost inefficiencies: lack of harmonization, duplication, opportunity cost risk and uncertainty. We then argue that another type of efficiency - dynamic efficiency - is important in analyses of capital market regulation. We seek an explanation for inefficiencies in the current regime. We argue that the securities regulatory system has resulted from a path dependent legal trajectory that is heavily influenced by federal-provincial tensions over securities regulation as well as the institutions responsible for dispensing regulation. Any reform proposal must either intervene in the development of this path dependent trajectory or be conceived on the basis of existing institutions. A single regulatory model is an example of such an intervention but may be less practicable than a passport or principal regulator system that allows existing provincial regulatory institutions to remain in place.

The Fall of Enron

The financial reporting and disclosure problems at Enron, as well as the high market valuations for its stock raise troubling questions about the functioning of capital market intermediaries, regulators and governance experts whose are supposed to ensure the effective functioning of the stock market. This paper examines the functions of key capital market intermediaries and analyzes how their own governance and incentive problems may have contributed to Enron's rise and fall. We conclude by proposing system modifications to resolve the observed problems.

Money laundering and terrorist financing: the role of capital market regulators

Outlines the special recommendations of the October 2001 meeting on terrorist financing, which complement the 40 Recommendations of the Financial Action Task Force (FATF), and the resulting FATF plan of action; they included ratification and implementation of UN instruments, criminalising the financing of terrorism and associated money laundering, freezing and confiscating terrorist assets, reporting suspicious transactions related to terrorism, international cooperation, alternative remittance systems, wire transfers, and non‐profit operations. Deals with the background problems: the vulnerability to money laundering in the securities and futures markets and businesses, concerns about anonymity and custodial accounts, the global anti‐money laundering guidelines for private banking issued in October 2000 by the ten major international private banks in Wolfsberg, and the responsibility of capital market regulators in the fight against money laundering and terrorism.

Modern Company and Capital Market Problems: Improving European Corporate Governance after Enron

Improving European corporate governance after Enron requires rethinking company and capital market regulation and law reforms. This article - which is an updated version (footnotes and references only, summer 2006) of an earlier one published in (2003) 3 Journal of Corporate Law Studies 221-268 - discusses shareholder decision-making; the choice between the one-tier and the two-tier board system; appointment, compensation and audit committees with a majority of independent members; checks on exorbitant payments to the directors; a special investigation procedure and wrongful trading. As to capital markets a European framework rule on prospectus liabilty is proposed. A key problem is the need for loyal and competent intermediaries. Since the 13th Directive is only a compromise solution, the hopes are pinned on the Court to continue its golden share case law. The German Volkswagen Act will be a test case.

Governance and Intermediation Problems in Capital Markets:
 Evidence from the Fall of Enron

The financial reporting and disclosure problems at Enron, as well as the high market valuations for its stock raise troubling questions about the performance of capital market intermediaries, regulators and governance experts whose are supposed to ensure the effective functioning of the stock market. This paper examines the functions of key capital market intermediaries and analyzes how their own governance and incentive problems may have contributed to Enron's rise and fall. We conclude by proposing system modifications to resolve the observed problems.

Foreign Portfolio Equity Investments, Financial Liberalization, and Economic Development

Reform of local capital markets and relaxation of capital controls to attract foreign portfolio investments (FPIs) has become an integral part of development strategy. The proximity of market openings and large, sudden shifts in international capital flows gave credence to the notion that the liberalization was the primary culprit in precipitating the recent Asian crisis. Hence, this paper reassesses the benefits and costs of FPIs from the perspective of the recipients. Specifically, it discusses the various FPI contributions and presents empirical evidence regarding the relationship between FPIs and market development, degree of capital market integration, cost of capital, cross‐market correlation and market volatility. It is clear that the evidence on benefits of FPIs is strong, whereas the policy concerns regarding resource mobilization, market comovements, contagion, and volatility are largely unwarranted. The authors make some policy suggestions regarding preconditions for capital market openings, market regulation, and liberalization sequencing.