Distorted Risk Incentives from Size Threshold-Based Regulations

82 Pages Posted: 3 Feb 2019 Last revised: 26 Apr 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: January 21, 2019

Abstract

Many regulations 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 risk around the Dodd-Frank Act, a major regulation with size thresholds. We provide empirical evidence that is consistent with the main predictions of the model.

Keywords: Risk incentives, Regulation, Size thresholds, Size contingent regulation, Dodd-Frank, Regulatory distortion, risk taking

JEL Classification: G18, G28, D21, D22

Suggested Citation

Hollifield, Burton and Illeditsch, Philipp K. and Johnson, Shane A. and Liu, Yan, Distorted Risk Incentives from Size Threshold-Based Regulations (January 21, 2019). Available at SSRN: https://ssrn.com/abstract=3320184 or http://dx.doi.org/10.2139/ssrn.3320184

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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