This paper studies the design of law-making and law enforcement institutions based on the premise that law is inherently incomplete. Under incomplete law, law enforcement by courts may suffer from deterrence failure, defined as the social-welfare loss that results from the regime's inability to deter harmful actions. As a potential remedy a regulatory regime is introduced. The major functional difference between courts and regulators is that courts enforce law reactively, that is only once others have initiated law enforcement procedures, while regulators enforce law proactively, i.e. on their own initiative. Proactive law enforcement may be superior in preventing harm. However, it incurs high costs and may err in stopping potentially beneficial activities. We study optimal regime selection between a court and a regulatory regime and present evidence from the history of financial market regulation.
Banking and Finance Law | Law | Law and Economics | Law Enforcement and Corrections
Chenggang Xu & Katharina Pistor,
Law Enforcement Under Incomplete Law: Theory and Evidence from Financial Market Regulation,
London School of Economics & Political Science (LSE), Suntory & Toyota International Centres for Economics & Related Disciplines (STICERD) Theoretical Economics Research Paper No. TE/2002/442
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