Capital-Market Effects of Securities Regulation: The Role of Implementation and Enforcement

This paper examines capital market effects of changes in securities regulation. We focus on two key capital market directives in the European Union (EU) that tighten market abuse and transparency regulation and enforcement. All EU member states are required to adopt these two directives but their exact implementation into national law and the design of enforcement regimes differ across member states. We use this setting to highlight that implementation and enforcement of regulation play an important role for regulatory outcomes. To identify the effects on EU capital markets, our research design exploits the differential timing of when countries implement the two directives. We find that, on average, market liquidity increases and firms’ cost of capital decreases as EU member states improve and tighten market abuse and transparency regulation. The capital-market effects are stronger in countries with a stricter implementation of the directives, in countries with traditionally stricter securities regulation and in countries with a better track record of implementing regulation and government policies. These cross-sectional findings underscore that the success of regulation depends critically on how well the rules are implemented and enforced. JEL classification: F30, G15, G18, G30, K22, M41