Distorted Risk Incentives from Size Threshold-Based Regulations

70 Pages Posted: 11 Dec 2017 Last revised: 4 Aug 2022

See all articles by Burton Hollifield

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business

Philipp K. Illeditsch

Texas A&M University - Mays Business School - Finance Department

Shane A. Johnson

Texas A&M University - Department of Finance

Yan Liu

Purdue University

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

Hollifield, Burton and Illeditsch, Philipp K. and 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

Burton Hollifield

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
(412) 268-6505 (Phone)
(412) 268-6837 (Fax)

Philipp K. Illeditsch

Texas A&M University - Mays Business School - Finance Department ( email )

Wehner Building 351Q
4113 TAMU | 210 Olsen Blvd
College Station, TX Brazos County 77843-4218
United States

HOME PAGE: http://https://sites.google.com/view/philippilleditsch

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)

Purdue University ( email )

West Lafayette, IN 47907-1310
United States

HOME PAGE: http://yliu1.com

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