Competition among Exchanges and Enforcement Policy
IMF Working Papers, February 1, 2013
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Bibliographic details
- Authors: Cecilia Caglio, Andrea Pescatori
- Published: February 1, 2013
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475516784.001
Summary and research question
- Explores how competition among stock exchanges, operated as self-regulatory organizations (SROs), affects the design of their members' surveillance.
- Develops a model with two for-profit SROs competing for trading volume, while brokers execute transactions on behalf of investors and may misreport the true cash flow.
- Investigates how SROs deter fraud by announcing an investigation and imposing a monetary penalty.
- Focuses on the role of resources devoted to monitoring and the efficiency of monitoring technologies in determining investigation success.
- Shows that when contracts are incomplete and investors do not have perfect information about monitoring efficiency, competition among exchanges induces a race to the bottom in enforcement policy and a reduction in total welfare compared to a monopolist SRO.
Model features and mechanisms
- Agents and institutions:
- Two for-profit SROs (exchanges) competing for trading volume.
- Brokers executing transactions on behalf of investors; brokers may misreport true cash flow.
- Investors with imperfect information about monitoring efficiency.
- Enforcement tools:
- Announcement of investigations.
- Imposition of monetary penalties upon detection.
- Determinants of investigation success:
- Amount of resources devoted to monitoring.
- Efficiency of monitoring technologies.
Main findings
- Competition among exchanges, under incomplete contracts and imperfect investor information about monitoring efficiency, leads to a "race to the bottom" in enforcement policy.
- This competitive weakening of enforcement results in a reduction in total welfare relative to a monopolist SRO.
Policy implications (as implied by findings)
- Weakening of enforcement incentives under competitive SRO structures can harm overall welfare.
- Informational asymmetries about monitoring efficiency are key drivers of reduced enforcement intensity in competitive settings.
- Design of regulation and oversight may need to account for incentives created by competition among SROs to avoid downward pressure on monitoring and penalties.