Winecoff_2012_VirtualAPSA

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The Politics and Economics of

Overcompliance

#VirtualAPSA2012

William Kindred Winecoff

University of North Carolina at Chapel Hill

September 1, 2012

William Kindred Winecoff The Politics and Economics of Overcompliance #VirtualAPSA2012 1/10
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The Question

What motivates the behavior of financial firms?

Prior theory (mostly taken from econ) universally expectsrace to the bottom behavior.

Functionalists: regulation can be welfare-enhancing.

Public Choice: regulation generates market failures via rent

capture.

One focuses on getting to the Pareto frontier; the other

focuses on where along the frontier we end up.

Sounds reasonable, but theres one problem:

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A Snapshot of Firms Risk, OECD

1990 1995 2000 2005

0

5

10

15

20

Year

CapitalAdequacyRatios(OECD

Averages)

OECD Tier 1 Mean

OECD Tier 1 + 2 Mean

Basel Tier 1 Minimum

Basel Tier 1 + 2 Minimum

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The Descriptive Empirics

Similar patterns in other regions.

Lots of variation at the firm level.Variation within across countries and time.

Essentially no literature explaining this. (Bernauer & Koubi 2006 as the

exception.)

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The Puzzle

Why would firms over-comply to this extent?

What political and economic forces drive the variation?

Why isnt there a race to the bottom?

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The Argument

Finance is different from other industries: both supply-side and

demand-side forces influence profits.

1 Banks profit by exploiting difference between interest paid

(for deposits) and interest earned (on loans).2 I.e., banks need to attract funds before they can invest them.

Thus have a need to signal prudence.

3 This signal is affected by firm-level characteristics in addition

to the macro political economy.

There is a demand-side incentive to race to the bottom; there is alsoa supply-side incentive to climb to the top. Banks can profit either

way. So which do they choose?

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The Hypotheses

Different types of institutions, operating in different types ofenvironments, make different choices:

Firms with riskier profiles (e.g. investment banks) and

publicly listed firms have greater need to signal prudence.

Large firms have lesser.

Firms in countries with regulatory central banks and highmonetary independence will have less capital. (Perhaps

monetary moral hazard?)

Firms in countries with super-equivalent local standards will

have higher.

Firms in poor countries cant signal effectively, in richcountries (e.g.) have less need.

Firms in countries with higher savings rates will face less

pressure for prudence; where there is lots of competition will

face more.

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The Data and Method

Data:

Bank-level data from BankScope.

National-level economic data from World Bank.National-level regulation data from World Bank surveys

(2000, 2003, 2006).

Method:

Bayesian regression (diffuse normal priors, 50k burn-in, 500k

post burn-in, fixed effects for countries and years).

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The Results

Generally as expected: variables at all levels matter:

Positive effect: listed institution, investment banks and

bank-holding corp, GDP growth, high income non-OECD,

inflation, countrys assets, super-equivalent regulation.

Negative effect: Firm assets, monetary independence,

regulatory central bank, poor and OECD countries, domestic

savings rate.

Less substantively significant effect: capital account

openness, exchange rate stability.

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Winecoff_2012_VirtualAPSA