India Economy

Financial regulations

D. MURALI | Updated on April 28, 2012

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Investor welfare is likely to be influenced by economic and financial regulations enacted in foreign economies, argues a recent research paper ( www.ssrn.com). Impact of comprehensive financial regulations, properly envisaged at the global level, is not confined to the home country, write Nicholas V. Vakkur, and Zulma J. Herrera in Ripple Effects: Sarbanes Oxley's Impact upon Investor Risk in a Global Economy. The paper opens by tracing how – after the collapse of Enron and reports of accounting fraud at WorldCom, HealthSouth, and other leading firms — the US Congress enacted the Sarbanes Oxley Act of 2002, ‘widely considered the most comprehensive economic regulation since the New Deal.'

Though, in the authors' view, Sarbanes Oxley “negatively impacted firms' risk-adjusted returns,” the enactment of the law in the US caused ‘ripple effects' by encouraging the adoption of similar laws in leading, non-US economies, to restore some sort of ‘global regulatory equilibrium.'

The initial sample in the study consists of the 500 largest US firms, as represented by the 2009 S&P 500, and the 500 largest European firms, as listed on the 2009 Bloomberg European 500 Index (BE500). Adding that the BE500 includes equities listed on 16 different European exchanges, and that the London Stock Exchange, Euronext (Paris), and the Xetra (Frankfurt) are the three most frequently represented, the authors aver that this represents the most comprehensive dataset used to analyse the impact of Sarbanes Oxley.

Useful read for financial researchers.

Investment trap

Investors should try as much as possible to avoid making investment decisions under conditions that heighten the need for closure. Thus advise David Disatnik and Yael Steinhart in The Need for Closure Trap: Application in Investment Decisions ( www.ssrn.com). An alarming finding in the paper is that when the decision process of high risk-averse individuals, with a desired end-state of reaching a relatively safe outcome, is motivated by a high need for closure, these individuals are prone to find themselves with a riskier investment even if the market uncertainty increases and a safer alternative exists.

Calling this the ‘need for closure trap,' the authors note that in these cases the motivation that drives the decision process overrides the goal and therefore investors are caught in a riskier investment that does not fit their high level of risk aversion. Such investors may become close-minded to additional information, which may be important for them to fulfil their ultimate goal of avoiding relatively risky decisions, one learns. Stating, therefore, that a motivational driver of the decision process can clash with the risk aversion level of investors, the authors suggest the study of interactions between the motivation of the decision process and its goal in other domains, too. They observe, for example, that the interplay between need for closure and an early adoption tendency may lead early adopters to keep an older version of a product rather than adopt the updated one.

Insights of value to the risk-averse!

Published on April 28, 2012

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