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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?