Distorted Risk Incentives from Size Threshold-Based Regulations

85 Pages Posted: 3 Feb 2019

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: 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

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

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

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