Distorted Risk Incentives from Size Threshold-Based Regulations

84 Pages Posted: 11 Dec 2017 Last revised: 19 Nov 2018

See all articles by Shane A. Johnson

Shane A. Johnson

Texas A&M University - Department of Finance

Yan Liu

Texas A&M University, Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: July 17, 2018

Abstract

Many regulations that affect firms and banks in the economy are based on size thresholds. We develop a model that shows that such regulations distort risk-taking incentives, providing above-threshold firms with greater incentives to take risk and below-threshold firms the opposite. Risk distortion varies nonlinearly as a function of the distance from the size threshold, and is increasing in the magnitude of the regulatory costs. We test our model by examining changes in bank risk around the Dodd-Frank Act, a major banking regulation with size thresholds. We provide empirical evidence that supports the main predictions of the model.

Keywords: Regulation, Risk incentives, Size thresholds, Size contingent regulation, Dodd-Frank

JEL Classification: G12, G18, G21, G28, G32

Suggested Citation

Johnson, Shane A. and Liu, Yan, Distorted Risk Incentives from Size Threshold-Based Regulations (July 17, 2018). Mays Business School Research Paper No. 3084239. Available at SSRN: https://ssrn.com/abstract=3084239 or http://dx.doi.org/10.2139/ssrn.3084239

Shane A. Johnson

Texas A&M University - Department of Finance ( email )

Mays School of Business
College Station, TX 77843-4218
United States
979-862-3318 (Phone)

Yan Liu (Contact Author)

Texas A&M University, Department of Finance ( email )

Wehner 401Q, MS 4353
College Station, TX 77843-4218
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
93
rank
252,585
Abstract Views
419
PlumX Metrics