Transcript When No Law is Better than a Good Law? Utpal Bhattacharya

When No Law is Better
than a Good Law?
Utpal Bhattacharya
Hazem Daouk
Discussant
Randall Morck
Jarislowsky Professor of Finance, The University of Alberta
William Lyon Mackenzie-King Visiting Professor, Harvard University
Research Association, National Bureau of Economic Research
No Law >> Unenforced Law
• No Drug Law
– Merck and Pfizer sell clean heroin at low prices
– Addicts, but no drug gangs
• Drug Law enforced
– No heroin
– No addicts, no drug gangs
• Drug Law, but imperfectly enforced
– Drug gangs sells impure heroin at high prices
– (Criminalized) addicts and (wealthy) drug gangs
• Fewer addicts? Maybe, or maybe not …
• Social welfare tradeoff
– Externalities of more addicts v. externalities of drug gangs
More Relevant Example
• No Murder Law
– Nice discussant comments
– Paper’s mistakes not corrected
• Murder Law enforced
– Negative discussant comments
– Improved paper
• Murder Law, but imperfectly enforced
– Nice people get negative comments and publish good
papers
– Scary people get nice comments and publish dumb papers
• Social Welfare calculation
– Greater collegiality v Needn’t read articles carefully
Insider Trading
• Reasons for insider trading laws
– Lower cost of capital to business
• Not necessarily of interest to established wealthy
– Appeasement of IMF, World Bank, foreign investors
• Does anyone pay attention to dead letters?
– Allows arbitrary prosecution of politically disloyal
locals
• Al Capone v. Putin
Posner: Probabilistic Enforcement
• In the model, the law is either enforced or not
– Perfect enforcement is impossible
– Pr(convicted) x penalty > benefit  effective
• Martha Stewart Effect?
– The US missed most insider trading, but when they catch
one, they crucify her
– Low Pr(convicted)  high penalty if convicted?
• Hillary Clinton Effect
– Cattle futures insider trades generate little money
– Benefit small  no point in risking trouble
• Recruit Effect?
– Japan rarely prosecutes insider trading cases
– Low penalty OK if Pr(public shame) large?
Is It Really Insider Trading?
• Bris estimate of insider profits prior to M&A from
1990 to 1999
9%
8%
7%
6%
5%
4%
3%
Enforced
Never Enforced
2%
1%
0%
Insider Trading Profits
Is It Really Insider Trading?
• Bris estimate of insider profits prior to M&A from
1990 to 1999
9%
8%
First Enforced in
1990 or earlier
7%
6%
5%
4%
First Enforced 1991
to 1999
3%
2%
1%
0%
Never Enforced
Insider Trading Profits
Latent Variables
• Having enforced an insider trading law once
doesn’t seem to suppress insider trading
around M&A
• Is insider trading around M&A events atypical?
• Might “having enforced an insider trading law”
be proxying for other factors that help a stock
market function better?
Latent Variables?
• The specification used is
• What if you run
• Does an insider trading law or its enforcement matter over and
above law and order in general?