nep-reg New Economics Papers
on Regulation
Issue of 2007‒10‒13
seven papers chosen by
Christian Calmes
University of Quebec in Ottawa

  1. Firm Regulation and Profit-Sharing: A Real Option Approach By Michele Moretto; Paola Valbonesi
  2. Portfolio effects and efficiency of lending under Basel II By Jokivuolle , Esa; Vesala, Timo
  3. Damages for Breach of Contract, Impossibility of Performance and Legal Enforceability By Germán Coloma
  4. Should Bank Supervisors in Developing Countries Exercise More or Less Forbearance? By Patrick Honohan
  5. Governance indicators : where are we, where should we be going ? By Kraay, Aart; Kaufmann, Daniel
  6. Rules for Border-Crossing Factor Movements By Horst Siebert
  7. Multiple safety net regulators and agency problems in the EU: is Prompt Corrective Action a partial solution? By Mayes, David G; Nieto, Maria J; Wall , Larry

  1. By: Michele Moretto (Università di Padova); Paola Valbonesi (Università di Padova)
    Abstract: To avoid the extremely high profit levels found in recent experience of public utilities’ regulation, some regulators have introduced a profit-sharing (PS) rule that revises prices to the benefit of consumers. However, in order to be successful, a PS rule should satisfy appropriate incentive conditions. In this paper, we study the incentive properties of a second best PS mechanism designed by the regulator to induce a regulated monopolist to divert its "excessive" profits to the customers. In a real option model where a regulated monopolist manages a long-term franchise contract and the regulator has the option to revoke the contract if there is serious welfare loss, we first endogenously derive the welfare maximising PS rule under the verifiability of profits. We then explore the dynamic efficiency of this PS rule under non-verifiability of profits and study the firm’s incentive to comply with it in an infinite-horizon game. Finally, we derive the price adjustment path which follows the adoption of a PS rule in a price cap regulation. We show that the riskiness of the distribution of the firm’s future profits and the regulator’s cost in revoking the franchise contract are key factors in determining the equilibrium properties of a dynamic PS rule.
    Date: 2007–10
  2. By: Jokivuolle , Esa (Bank of Finland Research); Vesala, Timo (Tapiola Group)
    Abstract: Although beneficial allocational effects have been a central motivation for the Basel II capital adequacy reform, the interaction of these effects with Basel II’s procyclical impact has been less discussed. In this paper, we investigate the effect of Basel II on the efficiency of bank lending. We consider competitive credit markets where entrepreneurs may apply for loans for investments of different risk profiles. In this setting, excessive risk taking typically arises because low risk borrowers cross-subsidize high risk borrowers through the price system that is based on average success rates. We find that while flat-rate capital requirements (such as Basel I) amplify overinvestment in risky projects, risk-based capital requirements alleviate the cross-subsidization effect, improving allocational efficiency. This also suggests that Basel II does not necessarily lead to exacerbation of macroeconomic cycles because the reduction in the proportion of high-risk investments softens the cyclicality of bank lending over the business cycle.
    Keywords: Basel II; bank regulation; capital requirements; credit risk; procyclicality
    JEL: D41 D82 G14 G21 G28
    Date: 2007–10–03
  3. By: Germán Coloma
    Abstract: This paper develops a game-theoretic model of a contract between a creditor and a debtor where equilibrium depends on the damage rule chosen for breach-of-contract situations, the use of impossibility-of-performance excuses and the level of legal contract enforceability. We find that, under perfect legal enforceability, the different alternative damage rules (based on expectation or reliance damages, with or without performance excuses) are able to induce an efficient performance by the contracting parties. But we also find that, if legal enforceability is imperfect, then a rule based on expectation damages with an excuse for impossibility of performance is able to work more efficiently than the other alternative damage rules.
    Keywords: breach of contact, impossibility of performance, legal enforceability
    JEL: K12
    Date: 2007–10
  4. By: Patrick Honohan
    Abstract: Although forbearance has been associated with more costly financial crises, a triggerhappy approach to closing weak banks could also precipitate an avoidable systemic collapse. In sophisticated regulatory environments, there can be net benefits from at least occasional acts of forbearance. But we argue that three key structural weaknesses in developing countries suggest that their regulators should have less forbearance discretion. This is because financial systems in developing countries tend to have worse information, less interdependence and greater agency problems.
    Date: 2007–10–02
  5. By: Kraay, Aart; Kaufmann, Daniel
    Abstract: Scholars, policymakers, aid donors, and aid recipients acknowledge the importance of good governance for development. This understanding has spurred an intense interest in more refined, nuanced, and policy-relevant indicators of governance. In this paper we review progress to date in the area of measuring governance, using a simple framework of analysis focusing on two key questions: (i) what do we measure? and, (ii) whose views do we rely on? For the former question, we distinguish between indicators measuring formal laws or rules ' on the books ' , and indicators that measure the practical application or outcomes of these rules ' on the ground ' , calling attention to the strengths and weaknesses of both types of indicators as well as the complementarities between them. For the latter question, we distinguish between experts and survey respondents on whose views governance assessments are based, again highlighting their advantages, disadvantages, and complementarities. We also review the merits of aggregate as opposed to individual governance indicators. We conclude with some simple principles to guide the refinement of existing governance indicators and the development of future indicators. We emphasize the need to: transparently disclose and account for the margins of error in all indicators; draw from a diversity of indicators and exploit complementarities among them; submit all indicators to rigorous public and academic scrutiny; and, in light of the lessons of over a decade of existing indicators, to be realistic in the expectations of future indicators.
    Keywords: Governance Indicators,National Governance,Public Sector Corruption & Anticorruption Measures,Economic Policy, Institutions and Governance,Banks & Banking Reform
    Date: 2007–10–01
  6. By: Horst Siebert
    Abstract: This paper analyzes rules for international factor movements, i.e. real capital flows together with the relocation of firms, the flow of technology and the migration of people. These rules have to make sure that individuals, individual countries as well as the world economy benefit from factor flows. They also define whether factors are accumulated, for instance whether new technology is found. Except for TRIMS, an international investment code has not been established. Conventions have been introduced to ease patent applications. TRIPS protects intellectual property. Rules for labor migration relate to the right of exit and to conditions of entry. Factor movements are interdependent among themselves and with trade. This implies a pecking order between trade, capital flows and migration.
    Keywords: International rules, institutional arrangements, capital flows, technology, patents, intellectual property rights, migration, pecking order between trade and factor flows
    JEL: F2 K O3 P
    Date: 2007–10
  7. By: Mayes, David G (University of Auckland and Bank of Finland); Nieto, Maria J (Banco de España); Wall , Larry (Federal Reserve Bank of Atlanta)
    Abstract: Prompt Corrective Action (PCA) provides a more efficient mechanism for dealing with problem banks operating in more than one European country. In a PCA framework, a bank’s losses are likely to be substantially reduced. This reduction in the losses to deposit insurance and governments will improve the problem of allocating those losses across the various insurance schemes and make it less likely that any deposit insurer will renege on its obligations in a cross-border banking crisis. This paper explores the institutional changes needed in Europe if PCA is to be effective in resolving the cross-border agency problems that arise in supervising and resolving cross-border banking groups. The paper identifies these changes starting with enhancements in the availability to prudential supervisors of information on banking groups’ financial condition. Next, the paper considers collective decision-making by prudential supervisors with authority to make discretionary decisions within the PCA framework as soon as a bank of a cross-border banking group falls below the minimum capital standard. Finally, the paper analyses the coordination measures that should be implemented if PCA requires the bank to be resolved.
    Keywords: banking supervision; European Union; Prompt Corrective Action
    JEL: F20 G28 K23
    Date: 2007–06–12

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