On Experimentation and Real Options in Financial Regulation

Matthew L. Spitzer
Eric L. Talley, Columbia Law School


In recent years, financial regulators have come under increasing judicial scrutiny for conducting inadequate cost/benefit assessments in advance of significant reforms. One facet of this scrutiny is judicial skepticism towards the proper role for regulatory experimentation (and the real option to abandon) within cost/benefit calculus. That is, regulators have arguably been discouraged from counting as a "benefit" the value of obtaining information through adopting new regulations on a trial basis, with an option to revert to the status quo at the completion of the trial. This paper studies a framework for assessing the role of "field experimentation" versus more standard forms of cost- benefit studies (or "analytic learning") within a regulatory/judicial hierarchy. We demonstrate that there is no principled basis for dismissing regulatory experimentation in cost/benefit analysis, and that such arguments deserve a place within regulators’ standard arsenals. Nevertheless, our analysis also helps explain an institutional reason for the tension between the judiciary and regulators, suggesting that regulators are plausibly too eager to embrace field experimentation, while judges are simultaneously too recalcitrant.?