A Model of Stock-Market-Based Rulemaking

39 Pages Posted: 6 Sep 2019 Last revised: 18 Dec 2020

Date Written: December 17, 2020

Abstract

We consider the extent to which a government regulator can harness information about its proposed rule from observing the stock price movements of the affected firms—information the regulator may in turn use to deliberate whether to adopt the rule. The rule comes with an uninformed ex ante (expected) value, which can be positive or negative. We find that if the rule’s ex ante value is positive and the regulator fully relies on the aggregate market reaction to guide its decision, then as the number of firms approaches infinity, prices will exhibit maximal informativeness. When the ex ante value is negative, however, the regulator’s reliance on the market will dampen speculators’ incentive to gather information, and prices will become completely uninformative. This latter effect, however, can be mitigated if the regulator’s reliance is only partial. We also consider the presence of stakeholders who may be motivated to manipulate the market to steer the regulator toward privately beneficial outcomes. We find that, as the number of firms approaches infinity, such stakeholders’ incentives to manipulate will dissipate. The theoretical findings of this paper suggest potential benefits of a stock-market-based rulemaking mechanism in the absence of other forms of reliable empirical evidence.

Keywords: stock market, price informativeness, Securities and Exchange Commission, agency rulemaking, feedback effects, real effects, financial markets, manipulation

JEL Classification: G18, G38, K23, K22

Suggested Citation

Lee, Yoon-Ho Alex, A Model of Stock-Market-Based Rulemaking (December 17, 2020). Available at SSRN: https://ssrn.com/abstract=3440321 or http://dx.doi.org/10.2139/ssrn.3440321

Yoon-Ho Alex Lee (Contact Author)

Northwestern Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States
(312) 503-2565 (Phone)

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