SEC Regulation

“Corporate Governance and the Creation of the SEC,” by Arevik Avedian, Henrik Cronqvist, and Marc Weidenmier. September 2014. SSRN #2498007.

“The Costs and Benefits of Mandatory Securities Regulation: Evidence from Market Reactions to the JOBS Act of 2012,” by Dhammika Dharmapala and Vikramaditya S. Khanna. July 2014. SSRN #2293167.

Does regulation of stocks and bonds by the Securities and Exchange Commission, with its regime of registration and mandated information provision, create net benefits for investors? In these pages, Michael Greenstone, Paul Oyer, and Annette Vissing‐​Jørgensen argued in the affirmative (“The Value of Knowing,” Summer 2006). They analyzed the effects of the Securities Acts Amendments of 1964, which extended the registration and disclosure regime to stocks traded “over the counter,” and found positive abnormal returns of $3–$6 billion. On the other hand, in these same pages Elizabeth de Fontenay compared corporate bonds subject to disclosure requirements with syndicated loans, which are not subject to such requirements (“Putting Securities Laws to the Test,” Fall 2014). She found the syndicated loan market to be thriving and growing, suggesting that investors found little value from the registration information requirements.

Now, two new working papers take up this question. The first, by Arevik Avedian, Henrik Cronqvist, and Marc Weidenmier, analyzes the effect of SEC regulation by comparing stocks listed on the New York Stock Exchange (NYSE) with stocks listed on the regional exchanges. The main effect of the 1933 Securities Act was to take NYSE listing standards at that time, convert them into federal law, and apply them to publicly traded firms on regional exchanges. The authors conduct a difference‐​in‐​differences analysis of NYSE and non‐​NYSE firms before and after the act’s creation of the SEC. Their measure is whether a majority of board members are “independent,” meaning they are neither officers nor family members of officers. The authors find a 30 percent reduction in board independence of the regional firms post‐​SEC, but no change in firm valuation by investors. Firms traded off private and public provision of reassurance. As government supply increased, the private supply of reassurance through board independence was reduced.

The second paper, by Dhammika Dharmapala and Vikramaditya Khanna, examines the effects of the JOBS (Jumpstart Our Business Startups) Act of 2012. The law relaxed disclosure and compliance rules for “emerging growth companies” (primarily those firms with less than $1 billion in revenue)—whose initial public offering (IPO) of stock was after December 8, 2011. The authors conducted an event study comparing small firms with IPOs between July 2011 and December 8, 2011 to small firms with IPOs between December 9, 2011 and April 5, 2012, when President Obama signed the bill into law. Some 87 firms conducted IPOs between July 2011 and April 5, 2012. The control group contains 33 firms with less than $1 billion in revenue whose IPO was prior to December 8, 2011.

The authors calculate whether differences in returns between treatment and control firms (so‐​called cumulative abnormal returns) exist in the event window (February 29 to April 9, 2012) surrounding a prominent March 15 statement by Senate Majority Leader Harry Reid’s (D–Nev.) about the importance of the bill. The event window starts with House Financial Services Committee’s approval of the bill, which included an explicit relaxation of the rules for all IPOs after Dec. 8, 2011, and ends four days after the presidential signing on April 5, 2012. The central result is positive abnormal returns of 3–4 percent for treatment relative to control firms during the event window. Investors reacted as if elimination of the SEC reporting requirements for small firms created net benefits that were reflected in positive abnormal returns.

Cash Transfers and Educational Attainment

“Human Capital Effects of Anti‐​Poverty Programs: Evidence from a Randomized Housing Voucher Lottery,” by Brian Jacob, Max Kapustin, and Jens Ludwig. May 2014. NBER #20164.

Why do poor parents have children who also grow up to be poor? One possible explanation is that poor families do not have access to credit that would allow parents to invest more in the human capital improvement of their children. The policy solution that results from this notion is to increase transfers to poor families in order to remove their credit constraints.

The expansion of the Earned Income Tax Credit (EITC)—which uses the tax system to transfer money to low‐​income households—has been shown to increase standardized test scores. But critics argue that factors unobservable to researchers but correlated with EITC receipt are responsible for children’s success, not the EITC transfers.

In this study, Brian Jacob, Max Kapustin, and Jens Ludwig use the 1997 housing voucher lottery in Chicago (the first opening of voucher lists in the city in 12 years). They examine the outcomes 14 years later for children whose families won housing vouchers versus children of families that did not. Families that won the lottery received a very large positive income shock—the equivalent of $12,000 a year—relative to the average income in the sample ($19,000 a year).

The authors find very few effects on schooling, crime, or health outcomes and none are significant. “Our estimates imply that extra cash transfers beyond the current level provided in the United States are likely to have a smaller impact per dollar than the best‐​practice educational interventions explicitly designed to improve children’s human capital,” they write. Their results are consistent with the findings of sociologist Susan Mayer, who concluded in What Money Can’t Buy (Harvard University Press, 1997) that there is “little reason to expect that policies to increase the income of poor families alone will substantially improve their children’s life chances.”

Air Pollution Regulation

“Toward a More Rational Environmental Policy,” by Richard L. Revesz. December 2014. SSRN #2534018.

Richard Revesz, professor of law at New York University, describes five principles that should govern environmental policy:

• Environmental restrictions on emissions should be governed by cost‐​benefit analysis and maximize net benefits.
• Environmental objectives should be achieved at minimum cost.
• Environmental policies should be implemented with market instruments such as emission prices or tradable emission permits.
• Grandfathering of emission sources introduces fatal arbitrage problems into environmental regulation and should be severely constrained. (See “New Source Review: What’s Old Is New,” Spring 2006.)
• The most compelling case for federal regulation is the control of interstate externalities.

From a libertarian perspective, the fifth principle is the most important. And yet one ironic response of states to the passage of the Clean Air Act amendments in 1970 and 1977 and their requirement that states enact plans to reduce stationary source emissions was to mandate taller smokestacks—a cheap solution that solved the intrastate problem by creating an interstate problem.

Rather than just reverse course and require the shortening of smokestacks to revert an interstate problem back into a local matter that the states would have to address, the federal courts, Congress, and the U.S. Environmental Protection Agency have been wrestling with the upwind–downwind problem ever since. The record of the courts and the EPA in tackling interstate pollution (at least partially created by the Clean Air Act itself) has not been very good. In 1984 the Sixth Circuit Court of Appeals ruled that an upwind Indiana power plant with no emission controls emitting six pounds of sulfur dioxide per million British Thermal Units (BTUs) of coal combustion had not violated the law even though it contributed almost half of the ambient pollution in downwind Jefferson County, Ky., and the power plant in Jefferson County emitted only 1.2 pounds of sulfur dioxide per million BTUs of coal combustion after investing $138 million in pollution control.

The EPA did not attempt to deal with interstate air pollution until 1998, during Bill Clinton’s second term. That effort was halted by the George W. Bush administration, which instead asked Congress to amend the Clean Air Act and explicitly expand the cap‐​and‐​trade market for sulfur dioxide (created by the 1990 Clean Air Act Amendments) to include other pollutants such as nitrogen oxides. The congressional reform attempt ended in 2005 when the bill failed to be approved by the Senate Environment and Public Works Committee on a 9–9 tie vote.

Revesz tells the story of how the courts finally allowed the EPA to implement a pollution reduction plan that minimized costs (specifically an emission rights trading regime) even though Congress failed to explicitly grant such permission through an amendment of the Clean Air Act. (See “An EPA War on Coal?” Spring 2013.) Shortly after the failure of the Senate committee to approve the Bush initiative in 2005, the EPA issued the Clean Air Interstate Rule (CAIR) to implement the Bush proposals administratively. In 2008 the D.C. Circuit Court of Appeals struck down CAIR because a strict reading of the statute was thought not to allow a trading program that reduced emissions based on the cost of reduction rather than the amount of pollution generated.

In 2011 the EPA responded with the Cross State Air Pollution rule, which again allowed the trading of emission reduction quotas, but with constraints so that all upwind states would have to reduce emissions rather than simply buy emission rights sufficient to allow their emissions. In 2012 the D.C. Circuit Court of Appeals struck down the Cross State rule because state emission limits were established on the basis of the cost of reduction rather than how much each state’s emissions contributed to the downwind ambient result. In 2014 the Supreme Court reversed the D.C. Circuit and concluded reductions could be allocated in a way that minimized aggregate costs.

For Revesz the story is positive because the courts finally allowed policy to be more rational. But that conclusion is possible only if one thinks that the courts rescuing the legislature from its enactment of “bad” statutes is a good thing and that interstate conventional pollution, itself, was not the unintended result of national attempts to make localities have “better” environments.

Bank Credit Supply and the Great Recession

“Do Credit Market Shocks Affect the Real Economy? Quasi‐​Experimental Evidence from the Great Recession and ‘Normal’ Economic Times,” by Michael Greenstone, Alexandre Mas, and Hoai‐​Luu Nguyen. November 2014. NBER #20704.

Ben Bernanke’s work on the causes of the Great Depression concluded that bank failures were an important contributor to the Depression’s length and depth. According to his research, lending was highly localized and the supply of credit to businesses was reduced by local bank failure.

Small firms, which are more reliant on bank lending, suffered disproportionate employment losses during the 2007–2009 “Great Recession.” Mindful of his findings on the Depression, Bernanke and Alan Krueger have both suggested that impaired bank credit markets were a major cause of overall employment losses in the recent recession. Hence, the Bernanke‐​led Federal Reserve implemented various direct lending programs to financial institutions to “fix” impaired credit markets for firms.

Despite the emergence of a national banking market in recent decades, small businesses still rely heavily on local lenders. The median distance between firms and lenders is only about three miles and only 14.5 percent of firms borrow from a lender located more than 30 miles from the firms’ headquarters.

During the last recession, banks reduced their lending to small businesses in widely varying degrees. For example, Citibank reduced small business lending by 84 percent while US Bankcorp reduced its lending by only 3 percent. Michael Greenstone, Alexandre Mas, and Hoai‐​Luu Nguyen exploit small firms’ reliance on local lenders and the differential lending cutbacks among regional banks to create a quasi‐​experimental research design.

They ask whether counties with more Citibank branches before the crisis experienced a greater reduction in lending and greater economic decline during the recession than counties with more US Bankcorp branches. The answer is yes but the magnitude is small. If you unrealistically consider all the lending decline to be supply‐​driven rather than attributing some of it to a recession‐​caused reduction in demand, then reduced lending would account for just 0.5 percentage points of the 10 percent decline in small business employment in the recession—about 5 percent of the decline. If you use the upper bounds rather than the average of the 95 percent confidence intervals of the estimated effects, you can explain 13 percent of the decline—a real but small effect. And this is for small businesses; larger businesses with access to non‐​local credit supply would be even less affected, if at all.