Presentation is loading. Please wait.

Presentation is loading. Please wait.

Evolution of Corporate Law & Finance Section (c)2 Corporate law & the business cycle Prof. Amitai Aviram College of Law University.

Similar presentations


Presentation on theme: "Evolution of Corporate Law & Finance Section (c)2 Corporate law & the business cycle Prof. Amitai Aviram College of Law University."— Presentation transcript:

1 Evolution of Corporate Law & Finance Section (c)2 Corporate law & the business cycle Prof. Amitai Aviram College of Law University of Illinois Copyright © Amitai Aviram. All Rights Reserved S12D

2 Effect of conspicuous law enforcement on behavior of non-perpetrators How the business cycle affects law Economic effect of the perp walk Conspicuous law enforcement Individuals risk perception Individuals behavior Nothing paints a picture as well as people being led away in handcuffs – Walter Ricciardi, SEC

3 When Do Prosecutors Enforce Securities Laws? Empirical Evidence Cyclical Enforcement: Little during boom, plenty after bust

4 When Do Prosecutors Enforce Securities Laws? Theory Conspicuous enforcement is greatest when the perception gap (perceived risk - actual risk) is greatest

5 Example Assume risk of company insiders committing fraud is 0.002% (1:50K) –But public misperceives risk to be 1% AG launches anti-fraud initiative (conspicuous law enforcement) –Insiders deterred: 50% reduction in objective risk, to 0.001% –AG oversells initiative; Claims 99% reduction (to perceived risk of 0.01%) Private benefits to AG: Public observes that actual occurrences are closer to 0.01% than 1%; lends credibility to AGs claims

6 Narrowing the perception gap: Over-estimation of fraud reduced from 0.998% to 0.009% –~111 times less misperception Perceived Risk (%) Actual Risk (%) Perception Gap Before % After % Example

7 Perception gap reduces social welfare: –Excessive avoidance of equity investments –Excessive self-policing of companies –Excessive political pressure to regulate Narrowing the perception gap increases social welfare Example Effect on Social Welfare

8 Bias Arbitrage Commodity Arbitrage Identify gap in price of gold in NY & London Take an action that creates private profits while also closing the price gap Bias Arbitrage Identify gap between objective & perceived risk Take an action that creates private benefits while also closing the perception gap

9 Is Cyclical Enforcement a Form of Bias Arbitrage? I.e., does the public over-estimate fraud more following a bust?

10 Does the public over-estimate fraud more following a bust? Cognitive Biases

11 Does the public over-estimate fraud more following a bust? Relevant Cognitive Biases Self-serving bias –Stock goes up – must be my investment skills –Stock goes down – must be fraud Availability bias –Economic hardship removes veil that masks fraud –Economic downturn causes hardship to many firms at once Attribution discounting –Fraud rises as a possible cause of downturn –Causes people to discount other causes

12 This could have been the end, but then this paper would be called … Counter- Cyclical Enforcement of Corporate Law

13 The Dual Message of Conspicuous Law Enforcement When Jane Doe hears that the SEC is investigating Acme Corp. for fraud, does she think: –The SEC is effective in catching fraud! (i.e., Ajax Corp. is less susceptible to fraud) Need to invest less in addressing risk Or: –I didnt realize theres so much fraud going on! (i.e., Ajax Corp. is more susceptible to fraud that I thought) Need to invest more in addressing risk

14 Reworking the Example Same assumptions as before, except that enforcement exacerbates perceived risk by 99% (to 1.99%) Perceived Risk (%) Actual Risk (%) Perception Gap Before % After % Perception gap increased Excessive avoidance Excessive self-policing Excessive political pressure

15 A vicious enforcement cycle… Public over- estimates risk Incentives for conspicuous law enforcement Conspicuous law enforcement Excessive avoidance / self-policing / political pressure Enforcement increases perception of risk

16 Solution? Counter-cyclical enforcement –Enforce more when public under-estimates fraud (boom) to increase risk perception –Enforce less when public over-estimates fraud (after bust) to prevent exacerbating risk perception But prosecutors incentives favor cyclical enforcement… –Article suggests mechanisms to modify these incentives


Download ppt "Evolution of Corporate Law & Finance Section (c)2 Corporate law & the business cycle Prof. Amitai Aviram College of Law University."

Similar presentations


Ads by Google