Does the enforcement of securities law by government authorities make a difference for market outcomes? This is an important question for policymakers and scholars and our focus in a forthcoming book chapter.

The academic debate on the question began with a publication by La Porta, Lopez-de-Silanes, and Shleifer (2006), who examined capital market development across countries and concluded that private enforcement through liability rules positively affected capital market development while public enforcement had negligible consequences. Yet subsequent empirical studies have provided evidence to the contrary.

In 2009, Jackson and Roe introduced resource-based measures of enforcement as a proxy for public enforcement intensity and concluded that public enforcement modelled in this way was consistently associated with measures of robust capital markets, the number of publicly traded firms, initial public offerings, and overall trading levels. Moreover, the authors noted that public enforcement performed at least as well as private enforcement, according to measures that earlier research identified as important to capital market development. Additional empirical research shows that on balance public enforcement is significantly associated with essential elements of capital markets like the private cost of capital and the accuracy of information. It also shows that greater public enforcement intensity is significantly associated with market variables of interest in countries that dedicate more resources to regulatory reform.

To be sure, a weakness of earlier papers is their use of cross-sectional analysis across many countries, which is poorly suited to determining causality. Fortunately, research using higher-quality data and more sophisticated statistical methods has now established that causality runs from enforcement to market outcomes and not in the opposite direction. For instance, several articles focusing on the enforcement actions of the SEC and allocation of commission resources show that the agency’s actions have real market effects, which strongly suggests that public enforcement matters in the United States.

Finally, we examine public enforcement in the realm of digital assets. Since the creation of Bitcoin, various other cryptocurrencies have emerged. They have been followed by derivative products, frequently referred to as “cryptoassets.” Much of the academic writing in this area has focused on whether cryptoassets are securities, commodities, currencies, or something else. But a separate question is whether public authorities should be more aggressive in taking enforcement actions with respect to this market. These issues came to the forefront after an eventful summer in 2022 – widely known as “crypto winter” – as cryptoasset prices plummeted and massive financial frauds were alleged.

A number of recent empirical studies have attempted to assess the impact of public enforcement on cryptoasset markets. We conclude that the initial wave of empirical research has yielded results without clear policy interpretations. For instance, many of the standard metrics employed in the study of securities markets – such as market capitalization to GDP or cost of capital to issuers or trading quality – are not well-defined for digital assets. Moreover, the volatility of cryptocurrency prices in the face of the crypto winter of 2022 may complicate additional empirical work for some time. Until the market for digital assets settles down, empirical analyses that focus on changes in market prices of digital assets is ambiguous, because it is possible that a reduction in price from enforcement efforts simply reflects a reduction in the likelihood that investors will be exploited in the future as opposed to a negative effect on legitimate economic value. The studies suggest, however, that public enforcement does have some measurable impact with respect to digital assets.

We acknowledge that much work remains in measuring the efficacy of public enforcement of securities laws. However, the weight of evidence suggests that greater levels of public enforcement are associated with key measures of robust capital markets.

This post comes to us from Howell Jackson, the James S. Reid, Jr., Professor of Law at Harvard Law School, and Jeffery Y. Zhang, assistant professor of law at the University of Michigan Law School. It is based on their recent chapter, “Does Public Enforcement Work?,” forthcoming in the Oxford Handbook of Corporate Law and Governance (Jeffrey N. Gordon and Wolf-Georg Ringe, eds.) and available here.