1. By Michael W. Zhang

2. Race to the Bottom In government regulation, a race to the bottom is a theoretical phenomenon which occurs when competition between nations or states leads to the progressive dismantling of regulatory standards. In financial regulation, regulation setters might want to reduce to cost of firms to make their own regulations more attractive.

3. Cost of Regulation(Disclosure) Predator cost Mandatory disclosure reveals information of the firms Documentary cost Papers and accountants are not free Internal control cost Resources are directed, monitored, and measured Punishment if “caught” Earnings management

4. Benefit of Regulation(disclosure) Investors’ confidence Investors are risk averse The variance of firms becomes less, the discount could also be less Stability of market Less bad apples Allocation of capital The investors have information before making investment Race to the top If the benefit dominates the cost, ……

5. Possible outcomes Race to the top Optimism Race to the bottom Pessimism One totally dominate the others Monopoly Separating Equilibrium NYSE vs. NASDAQ

6. Worst Cases Monopoly Local firms still have preferences of local markets and regulation Race to the bottom People are short horizon, cost dominates benefit in short run Consequences Bad capital allocation Volatile stock market Poor investors

7. My Experiment Goal To test which outcome is the result of competition between regulators Race to the bottom exist or not Schemes Ztree program 3 types of players: Regulation setters, firms(IPO) and investors Second-price, sealed-bid auction Results

8. Players Firms: Observation: Firm’s own signals and all public info Objective: To maximize the sell price Choices: Different regulators with different requirement of disclosure Investors: Observation: Public info, their own bids Objective: To maximize the profit Profit = liquidation value – Price Choices: Bid price

9. Liquidation Value There is a discount for disclosed information is the discount rate

10. Players Regulators: Observation: Public info Objective: To get as many firms as possible I assume a firm will pay a fix amount a fee to the regulator This amount is relatively small comparing to the firm value Choices: Different level of disclosure Each firm has five signals, the regulator will set the disclosure level of the firms

11. Information Public information Disclosed information by firms Winning price of the bids Firms’ choices of regulators Regulation setters’ choices of disclosure level Private information Investors’ own bid Firms’ undisclosed information

12. Timeline of the Experiment Regulators decide the disclosure level Firms observe their signals, then choose one regulator or “ventral capital” The first firm’s disclosed information becomes public knowledge, and it is sold to public in second-price, sealed-bid auction The price and the profit of the winner becomes public knowledge The second and following firms are sold

13. Information Asymmetry and Liquidation Value When the disclosed signals does not convey any information about undisclosed signals The discount rate is crucial ( 1/2) When the disclosed signals does convey information about undisclosed signals Different firms have different distributions of signals Disclosed information might reveal the underlying distribution of the firms’ signals

14. Program Background Number of players Firms Investors(Regulators) Firm’s signal 5 signals Timeline of Experiment

15. Use of Time Regulator's setting90 Firm Time90 Investor time90 Individual investor's result30 Outcome of the bid30 Total time each period (Seconds)330 Total time each period (Minutes)5.5 Total experiment time55 Explain of experiment and Trial30 Total experiment time55 Waste at beginning15 Stop 15 mins before end15 Total class time used115

16. Choices of Regulators Choice of disclosure requirementRegulator ARegulator BRegulator CAverage P11142 P22222 P34222.666666667 P43232.666666667 P55212.666666667 P65333.666666667 P75444.333333333 P81221.666666667 P93153 P104143 P111242.333333333 Average over periods3.0909090912 2.727272727

17. Top and Bottom of Regulators BottomTopDiff P1143 P2220 P3231 P4231 P5154 P6352 P7451 P8121 P9154 P10143 Average of regulation1.83.82

18. Choices of the Firms PrivateBottomTop P1033 P2033 P3042 P4033 P5112 P6213 P7411 P8222 P9042 P10123 total number of firms1024

19. Further Work Improve the efficiency of the program to save some time Make people excited (too much idle time) Add enforcement as a parameter Design of information Secondary market ??