A Model of Stock Market-Based Rulemaking
28 Pages Posted: 6 Sep 2019
Date Written: August 20, 2019
We consider the extent to which a government regulator can harness information about its proposed regulation from stock-price movements of affected firms — information the regulator may in turn use to deliberate whether to move forward with the regulation. We find that if the proposed rule’s ex ante value is positive and the regulator relies on the market completely, then as the number of firms increases, stock prices will exhibit maximal informativeness. When the rule’s ex ante value is negative, however, the regulator’s reliance on the market will dampen speculators’ incentive to gather information, and stock prices become uninformative. This latter effect, however, can be mitigated if the regulator’s reliance is only partial. In extensions, we consider the presence of a stakeholder who may be motivated to manipulate the market and steer the regulator to a privately beneficial outcome. We find that, as the number of firms increases, the stakeholders’ incentives to manipulate the market will dissipate and they will find it beneficial to trade in a manner consistent with speculators. The theoretical findings of this paper suggest potential benefits for the regulator to engage in stock market-based rulemaking 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: Suggested Citation