7 (Econ) - Economics of Regulation Flashcards
Why/when are regulations needed?
Regulation is needed in the presence of informational frictions, externalities, weak competition, or to achieve specific social objections.
Informational Friction
An occurrence when information is not equally available or distributed.
Information Asymmetry
A situation when some market participants have access to information that is unavailable to others.
Externality
What do externalities typically deal with?
Costs and benefits that affect a party that did not choose to incur that cost or benefit. Externalities typically deal with the provision of public goods.
What can weak competition lead to?
Fewer choices, higher prices, and lack of innovation. Antitrust regulations seek to mitigate this problem.
Explain the purpose of social objections in regulation?
Typically deals with the provision of public goods. People share in the consumption of public goods but don’t necessarily bear the costs that are proportional to consumption so regulation is needed to ensure an optimal level of production of such public goods.
Prudential Supervision
What does prudential supervision include?
The regulation and monitoring of financial institutions (e.g. banks, etc.) to reduce system-wide risks and to protect investors.
This includes diversification of assets, an adequate capital base, and risk management activities of such financial institutions.
What are examples of regulations that cover commerce?
What is the result of regulating commerce?
- Company law
- Tax law
- Contract law
- Competition law
- Banking law
- Bankruptcy law
- Dispute resolution systems
This type of regulation may either facilitate or hinder commerce.
What is the goal of antitrust regulation?
Provide an example of antitrust regulation.
Antitrust regulation seeks to promote competition amongst domestic businesses. They promote domestic competition by monitoring and restricting activities that reduce or distort competition. Antitrust regulation also seeks to hinder foreign competition thus protecting domestic businesses.
Antitrust regulators will often block a merger/acquisition that would lead to an excessive concentration of market share and as a result, weakened competition in a specific industry.
What are example of anticompetitive behavior?
- Discriminatory pricing
- Price collusion
- Bundling
- Exclusive dealing
All of which are often prohibited by antitrust regulation.
What does security market regulation include? What does security market regulation seek to mitigate?
Security market regulation includes protecting investors by requiring firms to provide adequate disclosures.
This regulation effort mitigates agency conflicts and protects smaller (i.e. retail) investors.
What are the three major goals of financial/security market regulation?
- Protect investors
- Create confidence in the markets
- Enhance capital formation
Regulation of such markets ensures the stability of the financial system and maintains the integrity of markets.
Statues
Laws made by legislative bodies.
Administrative Regulations
Laws issued by government agencies or other bodies authorized by the government.
Judicial Law
Laws based on findings of the court.
Independent Regulator
Regulators are given recognition by government agencies and have the power to make rules and enforce them. However, they are usually not funded by the government and hence are politically independent.
What is the difference between Self-Regulating Bodies (SRBs) and Self-Regulating Organizations (SROs)?
SRBs are private organizations that represent as well as regulate their members. They are not given government recognition and authority to enforce.
SROs are the same as the above except they are recognized by the government and given enforcement powers. Given their government recognition, they are independent regulators.
Outside Bodies
What are examples of outside bodies?
Not regulators themselves but their products tend to be referenced/used by regulators.
Examples include FASB and IASB as regulators will reference their protocols, etc.
Where are SROs most prevalent?
Are SROs typically successful?
In common-law countries (e.g. USA or UK) rather than civil-law countries.
When they are properly supervised by regulatory agencies, SROs have been effective in carrying out the objectives of such regulations.
FINRA
What is its primary goal?
Financial Industry Regulatory Authority.
SRO that is recognized by the SEC (a government agency) in the USA.
FINRA regulates broker-dealers in the USA and its primary objective is to make sure they are operating fairly and honestly and, in turn, protect investors by maintaining the fairness of the US capital markets. They can enforce security laws and regulations.
Regulatory Capture Theory
Who is this more likely to be a concern with?
The theory that, regardless of the original purpose behind its establishment, a regulatory body will, at some point in time, be influenced or even possibly controlled by the industry that is being regulated. The rationale behind the theory is that regulators often have experience in the industry and this experience affects their ability to render impartial decisions.
This is more likely to be a concern with SROs or SRBs than with government agencies.
Regulatory Competition
Regulators compete to provide the most business-friendly regulatory environment.
Regulatory Arbitrage
When firms exploit the difference between regulatory differences between jurisdictions. Can also be when firms exploit the difference between real economic substance and an interpretation of a regulation.
What are the three major regulatory tools available to regulators?
- Price mechanisms - taxes, subsidies, etc.
- Restricting or requiring certain activities. - disclosures, etc.
- Provision of public goods or financing of private projects - examples would be national defense, SMB loans, student loans, etc.
Regulatory Burden (aka government burden)
The cost of complaint for the regulated entity.
Sunset Clause
A measure within a statute, regulation, or other law that provides for the law to cease to be effective after a specified date. Unlike most laws that remain in force indefinitely unless they are amended or repealed, sunset provisions have a specified expiration date.
What do sunset clauses require?
They require a cost-benefit analysis to be done before a regulation should be renewed.
What needs to be considered when doing a cost-benefit analysis of a certain regulation?
the indirect costs of that regulation on the industry, economy, or society.
Why is regulation important in financial analysis?
Regulation can have a material impact on industries and companies. Certain industries have more exposure to certain types of regulations than others.
An analyst should always be considering the impact of current and proposed regulations as regulators can have a large impact on valuations for a particular company or industry.
