## Competition among Exchanges and Enforcement Policy

_IMF Working Papers, February 1, 2013_

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**Canonical URL:** [Competition among Exchanges and Enforcement Policy](https://www.imf.org/en/publications/wp/issues/2016/12/31/competition-among-exchanges-and-enforcement-policy-40296)

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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

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### 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.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/competition-among-exchanges-and-enforcement-policy-40296_