Public and Private Rule Making in Securities Markets
UVA Law Faculty Affiliations
Recent corporate scandals have ignited debate over appropriate rules for accounting and corporate governance. The debate has largely ignored an important preliminary question: who should set standards of corporate governance and disclosure for publicly traded companies? This paper argues that stock exchanges have substantial advantages, in comparison with government bodies, as the primary regulators of corporate governance, disclosure, and accounting. Those advantages stem from superior incentives. Stock exchanges gain from investors’ willingness to trade and accordingly have an incentive to provide any cost‐effective rules that will increase investor welfare. There are several standard arguments against increasing the role of exchanges in setting disclosure and governance rules. One is that exchanges have market power, which dulls their incentive to set optimal rules. Another is that competition for listings will make exchanges reluctant to enforce their rules. A third is that disclosure rules have external effects that an exchange cannot internalize. Finally, it is argued that exchanges may lack sufficiently varied enforcement tools to ensure compliance with their rules. Under current practice, the primary threat exchanges can hold over listed companies is delisting, which may be too large a penalty for some violations and too slight for others. Only the last of those is a significant obstacle, and even that can be resolved contractually to some extent. Listing agreements could call for fines and other penalties for violation of rules. Nevertheless, government agencies have a clear advantage in investigating and punishing wrong‐doing. A natural solution, then, would be to maintain the Securities and Exchange Commission as an enforcement agency but cede much of its rule‐making authority to the exchanges.