Abstract
La Porta, Lopez-de-Silanes, and Shleifer (J Financ 61:1–32, 2006) (LLS) have undertaken an empirical analysis, making a critical but somewhat provocative proposition that “securities laws ‘facilitating’ private enforcement, rather than providing for public enforcement, benefit the securities market.” After briefly providing a theoretical connection to the existing law and economics literature, I attempt to empirically advance this LLS proposition two-fold, particularly on the ‘joint use of regulation and the liability rule,’ by exploring the most meaningful word ‘facilitate’ therein. Firstly, I explore the cross-country LLS data associated with the specific case of an initial public offering to seek possibly more solid evidence on the facilitating effect. Secondly, motivated by LLS, I pursue a within-country positive analysis, regarding the major determinants of the joint use, but across overall harmful activities covered in the Korean Securities Law. The major tenet underscoring this second empirical exploration was the clear message from the existing theoretical literature that the joint use should be adopted in a selective manner even within a single substantive statute, because it usually governs vastly different harmful activities. Finally, I call for some essential research agenda, prior to approving the ineffectiveness of public enforcement claimed in the second part of the LLS proposition.
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Notes
LLS then portrays proxy LS alone to represent the common law regime of the unregulated securities market, DR (along with LS) the securities law regime to standardize liability in securities transactions, and finally PE the publicly monitoring and penalizing regime by an independent government enforcer such as the SEC of the US. According to their definitions, I recognize that the characteristics (and thus the numerical values) of DR and PE are almost entirely determined by the statutory securities laws in most countries, while those of LS, too, can be affected by them to a nontrivial extent, for example, by explicitly stipulating the degree of burden of proof into the securities laws.
In contrast to the literature in this section, it is well known that from the early 1970s there had existed in fact more theory papers where ‘regulation’ and ‘liability’ are instead treated mutually substitutable and/or competing. Some of these papers will be introduced in Sect. 3.
While dealing with a more generalized model encompassing an uncertain regulatory standard, too, Burrows reached a similar conclusion to that in KUJ. Especially in the case where a regulatory standard is a certain instrument and liability is an uncertain instrument, Burrows (1999, p. 232) showed that “the impact of an uncertain instrument [i.e., LS in the context of LLS] on the injurer’s choice of precaution level can be altered by the very presence of another instrument [i.e., DR in the context of LLS] whether that one is certain or not.” ([] added)
As such, in order to reflect it more completely, one might want to specify an empirical equation in which DR and LS operate not ‘separately’ but somehow ‘interdependently’ as explained in the next section.
I got it from http://www.post.economics.harvard.edu/faculty/shleifer/papers/securities_data.xls, for which I am grateful to the authors. (The data file however did not include one dependent variable, Liquidity, out of the seven originally used in LLS.) I verified that the data set was identical, for example, because the coefficient estimates in Panel A in Table 3 of LLS were identical down to three decimal places. Although there were some differences in significance levels of the coefficient estimates, they were thought to be somewhat negligible. For convenience, I have shortened the variable names slightly: ADR = Anti-director rights in LLS, ln PC_GDP = Log GDP per capita, EJ = Efficiency of the judiciary, Mkt_Cap = External cap/GDP, No._Firms = Domestic firms/pop, IPOs = Initial public offerings, B_Premia = Block premia, Access = Access to equity, Concentration = Ownership concentration.
I added PE to Panel A in Table III of LLS. While all the six coefficient estimates of DR were significant with similar Adj. R 2s, PE was not significant just as in Panel C. My further effort to capture any interactive effect between DR and PE turned out to be unproductive, too. PE was next added to Panel B, causing no visible changes in estimation results in LS. PE was significant only in a single case, and any interactive effect between them was not detected. Therefore, at least according to this particular dataset and model specification, the role of PE must have been indeed minimal in producing the horse race estimation mentioned in the text. Most importantly, when I finally added DR to Panel B, however, a disappointing result was encountered. Although coefficient estimates of DR were significant in five equations, LS was significant only in one equation; the result was almost identical to that of the horse race termed as LLS in Table 1 of this paper.
This will be reconfirmed in my empirical analysis later.
Similar results were obtained when the dummy variables were constructed based on the means of DR and LS instead of their medians.
To be sure, it would be conventional to include the level variables, i.e., DR and LS, together with these interaction variables. However, I was afraid to encounter again the aforementioned pervasive multicollinearity between DR and LS. Additionally, the correlation coefficients between them and these interaction variables seemed to be also problematic. For example, they were 0.68 and 0.58 between the level variables and DR_H*LD_H, respectively, in turn forcing me to incorporate the interaction variables only. In fact, estimation results with the level variables incorporated were far inferior to even those of LLS in Table 1, and its main cause, based on the VIF (variance inflation factor) test, turned out to be the much worsened multicollinearity problem.
The former statement in this paragraph is consistent with an argument reflecting the actual securities market such as: “Counting on an administrative agency to enforce the law is a mistake, since the agency is more likely to listen to corporate managers than to complaining shareholders.” (Hay and Shleifer 1998, p. 402). In contrast, the latter statement is in line with, for example, the contention that the 1933 Securities Act of the US, along with the previously existing private liability alone, lowered the investor’s forecast error through additionally mandating financial disclosure (Simon 1989, p. 295). Furthermore, Coffee’s argument (2002, p. 1403) that statutory securities regulations help standardize more clearly the liability of, and consequently deter, gatekeeper failure is compatible with both statements in the text.
In this preliminary survey, for the US I referred to the Securities Act of 1933 (especially §11, §12(a)(1) & (2), §15), the Securities Exchange Act of 1934 (especially §9(e), §18(a), §20(a), §20A(a)), the SEC Rule based on §10(b) of the 1934 Act (especially Rule 10b-5), and Loss and Seligman (2004). Rule 10b-5 appears to play an important role in bringing private liability suits backed up by the so-called the ‘private right of action’ supported by the court’s judgments, the representative example of which is Herman & MacLean v. Huddleston (459 U.S. 375, 380–381 n.10 [1983]).
Although there are 18 damages clauses explicitly stipulated in KSL as discussed in detail later, the joint-use degree is lower than that of the US for the following reasons. First, the plaintiff’s burden of proof is lessened compared to the common law (i.e., the private law) only in a subset of the 18 clauses. Second, the prescription to file a private suit is shortened to about one-third of that in the common law. Third, my random survey of actual court cases indicated that the vast majority of securities-related suits have in practice been filed based on the common law rather than on the KSL.
Finally, for Japan (the Securities and Exchange Law) and Germany (the Stock Exchange Act; Börsengesetz), my survey was relatively more limited due mainly to data constraints and to lack of my expertise, which naturally makes the survey result very preliminary. I referred mostly to Soulier and Best (2004), Krause (2001), and the Korea Legislation Research Institute’s website (http://www.klri.re.kr). In Japan there are 16 statutory damages clauses and the overall situation seems to be similar to Korea in general. In contrast, the private damages suit is explicitly allowed in the German statute only for the case of the defendant’s gross negligence.
To enhance the consistency in classifying regulations, the following three sampling rules were applied: (i) An article (§) with two or more sub-articles mandating some obligations is treated as a single regulation as long as identical (combinations of) penalties are imposed on those sub-articles. (ii) Sub-articles followed by different penalties within an article are sampled as different regulations. (iii) Different articles are classified as independent regulations in spite of the identical set of penalties imposed.
They are §14, §25-3, §41, §58 ①, §95 ②, §97 ①, §154, §179 ④, §180 ③, §186 ④, §186-5, §188-3, §188-5, §189 ⑤, §189-2 ⑤, §190-2 ③, §192-3 ⑥, §197. Historically, §14 was introduced into KSL in 1963, and §197 followed in 1973. In 1976 the legislature introduced seven damages clauses including §41, subsequently §188-3 in 1991, and again seven clauses including §86 ④ in 1997 upon the Korean liquidity crisis. Most recently, §189 ⑤ was included in 2001.
In fact, strictly following the definition in the text, I initially obtained 125 regulations in KSL. However, 13 of them are associated with repeated noncompliance of the administrative orders (such as suspension or discharge orders) ‘already imposed’ upon initial violation of regulation by the regulated party. They were excluded, considering the main analytic purpose of the empirical work later in this section.
As can be easily inferred, these 7 cases (§41, §58 ①, §95 ②, §97 ①, §189 ⑤, §192-3 ⑥, §197) are liability clauses themselves. However, according to the definition of regulation adopted earlier, the 7 liability clauses are considered as regulations, too.
“Unlike reputational intermediaries, ... insiders often have little wealth outside their firm or can hide much of their wealth out of investors’ reach. Moreover, the prospect of disgorging one’s ill-gotten gains, with probability less than one, won’t adequately deter crooks from attempting fraud in the first instance.” (Black 2001, p. 797)
“The allocation of monetary sanctions between principals and agents would matter, however, if some allocation allows the pair to reduce their total burden. ... [damages] therefore should be imposed on the principal rather than on the agent. ... the imposition of imprisonment sanction on agents may be desirable ...” (Polinsky and Shavell 2000, p. 64, [ ] added)
Econometrically, P and A cannot enter the equation simultaneously, either. That is because, by definition, a case when ‘P = 0 and A = 0’ will have a value of 1 for Joint. Thus, the simultaneous inclusion can be almost equivalent to including H into the equation.
According to their definitions, just like the stage of regulatory variables earlier, neither ‘LB alone’ nor ‘CP and AP simultaneously’ can be used in the empirical equation.
They show that possibility of agency costs in the delegation of law enforcement (i.e., under-enforcement by the regulatory agency), in legal error (i.e., agency’s convicting the innocent), and in collusion (i.e., corruption) between the agency and the offender might justify the imposition of a criminal sanction on top of a regulatory penalty.
F2 was initially excluded primarily because F2 had much higher correlation coefficients (than that between F1 and F3) with F1 and F3 (−0.76 and −0.51, respectively).
As explained APand CP cannot enter the equation together. Since the correlation coefficient of AP and CP_AP was high (0.7), I chose CP to avoid multicollinearity. When I replaced it with AP, the model collapsed.
I appreciate a commentator who kindly suggested these tasks upon reading the very first draft of this case study.
Very limited backgrounds are: In the US, for example, private damages suits by the plaintiffs related to a target company seem to be usually allowed by the courts decisions based on §14(e) of the 1934 Securities Exchange Act (Loss and Seligman 2004, pp. 1270–1271). The representative court cases being cited include H. K. Porter Co. v. Nicholson File Co. (482 F.2d 421, 1st Cir. [1973]) and Field v. Trump (850 F.2d 938, 2d Cir. [1988]). It was also encouraging to encounter Hauch’s (1987, pp. 118–119) contention that private litigation particularly against the financial intermediaries involved in M&A would supplement effectively the enforcement activity of the SEC.
This observation is almost identical to an anonymous referee’s opinion upon reading an earlier version of this paper: “The public enforcement of securities regulations may have a role to play. .... [Enforcing] clear regulatory norms may be desirable when [private law such as] tort law rules are uncertain.” ([] added)
The five sub-indices included supervisor characteristics such as type of appointment and tenure, rule-making power, investigative power, orders-issuing power, and the scope of criminal sanctions. Also, as mentioned before, I was not able to find any significant coefficient estimates for various interaction variables between PE and LS while undertaking my empirical experimentation in Sect. 2.
One of the most fundamental agenda in designing ideal bureaucratic organizations enforcing monetary or financial regulations would be how to balance such powers of discretion with effective accountability measures and incentive-compatible conditions, as has been repeatedly emphasized in the literature, for example, again recently by Kim and Kim (2007).
The reallocating (or focusing) task must be carried out, also preferably through revising outright the securities laws, to realize better the comparative advantage of public enforcement versus private enforcement, as representatively spelled out in Polinsky and Shavell (2000, pp. 45–46). Refer to LLS (pp. 2–3) for the research examples taking this stance on the securities market regulation.
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Acknowledgments
I appreciate constructive comments and encouragement on earlier versions of this paper from Soohyun Ahan, Hwajin Kim, Ivan P’ng, Dochull Shin, Jinsu Yune, Chenggang Xu, and several participants, among others, in the Asian Law and Economics Meetings, the Korean Law and Economics Meetings, and the Korean Association of Comparative Private Law Meetings. Encouragement and suggestions by the editor and the referee are greatly acknowledged. Also, I am grateful for excellent research assistance provided by Jinho Kim and Byungwook Mo. Finally, this work was suported by the Korean Research Foundation Grant funded by the Korean Government (KRF-2005-041-B00129). The usual caveat applies.
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Kim, I. Securities laws ‘facilitating’ private enforcement. Eur J Law Econ 25, 17–38 (2008). https://doi.org/10.1007/s10657-007-9039-1
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DOI: https://doi.org/10.1007/s10657-007-9039-1