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

This paper examines capital market effects of changes in securities regulation. We analyze two key directives in the European Union (EU) that tightened market abuse and transparency regulation and its enforcement. All EU member states were required to adopt these two directives but did so at different points in time. Our research design exploits this differential timing of the same regulatory change to identify the capital-market effects. We also use crosssectional variation in the strictness of implementation and enforcement as well as in prior regulation to analyze the role of these factors for regulatory outcomes. We find that, on average, market liquidity increases as EU countries tighten market abuse and transparency regulation. The effects are larger in countries that implement and enforce the directives more strictly. They are also stronger in countries with traditionally stricter securities regulation and with a better track record of implementing regulation and government policies in general. The results indicate that the same forces that have limited the effectiveness of regulation in the past are still at play when new rules are introduced, leading to hysteresis in regulatory outcomes. The finding also illustrates that imposing the same regulation in countries that differ in their initial conditions can make countries diverge more, rather than move together, which has important implications for global regulatory reform. JEL classification: F30, G15, G18, G30, K22, M41