Review of Finance Advance Access originally published online on June 17, 2009
Review of Finance 2009 13(4):577-627; doi:10.1093/rof/rfp011
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When No Law is Better Than a Good Law*
1 Indiana University
2 Cornell University
This paper argues, both theoretically and empirically, that sometimes no securities law may be better than a good securities law that is not enforced. The first part of the paper formalizes the sufficient conditions under which this happens for any law. The second part of the paper shows that a specific securities law – the law prohibiting insider trading – may satisfy these conditions. The third part of the paper takes this prediction to the data. We find that the cost of equity actually rises when some countries enact an insider trading law, but do not enforce it.
JEL Classification: G15, G18, K22, K42
* We thank Arturo Bris, Stijn Claessens, Michel Habib, Geoff Miller, Randall Morck, Kazuhiko Ohashi, Paul Tetlock, Sheridan Titman, John Wald and participants in the seminars or conferences at the 2008 American Finance Association Meetings in New Orleans, Bank of Japan, Case Western Reserve University, French Finance Association Meeting, Goethe University, Harvard Law School, Hebrew University, Hitotsubashi University, Indiana University, Istanbul Stock Exchange, KOC, McMaster University, MIT, Purdue University, Rice University, Sabanci University, Shanghai Conference on Corporate Governance, Southern Methodist University, Stockholm School of Economics, Tel Aviv University, Texas A&M University, University of Alberta, Universidad de San Andres, Universidad Torcuato di Tella, UC Riverside, UT Austin, UT Dallas, University of Hohenheim, University of Iowa, University of Lugano, University of Missouri-Columbia, UT San Antonio, University of Tokyo, University of Toronto, University of Waterloo, World Bank and Yokohama University for improving the paper. Special thanks go to Guohua Li for being such a careful research assistant. We are grateful to Sam Henkel (www.samhenkel.com/data) for providing some of the liquidity data used in the paper. Hazem Daouk acknowledges financial support from the Peter J. and Stephanie J. Nolan Professorship of Finance.