When No Law is Better than a Good Law

Abstract

This paper argues, both theoretically and empirically, that sometimes no security law may be better than a good security law that is not enforced. The first part of the paper formalizes the sufficient conditions under which this happens for any law. The second part of the paper shows that a specific security law - the law prohibiting insider trading - may satisfy these conditions, which implies that our theory predicts that it is sometimes better not to have an insider trading law than to have an insider trading law but not enforce it. The third part of the paper takes this prediction to the data. We revisit the panel data set assembled by Bhattacharya and Daouk (2002), who showed that enforcement, not the mere existence, of insider trading laws reduced the cost of equity in a country. We find that the cost of equity actually rises when a country introduces an insider trading law, but does not enforce it.