Discipline.qxd 10/14/04 3:06 PM Page 1 economics/finance countries and industries market discipline across contributors MARY E. BARTH KRISTIN J. FORBES STANISLAVA NIKOLOVA MARCO BECHT CHARLES FREEDMAN MARIA SOLEDAD MARTINEZ PERIA market discipline GEORGE J. BENSTON MITSUHIRO FUKAO HUGH PATRICK SUSAN SCHMIDT BIES REINT GROPP RICHARD PORTES across countries ROBERT R. BLISS ANDREW G. HALDANE JEAN-CHARLES ROCHET and industries GERARD CAPRIO SCOTT E. HARRINGTON ANDREW K. ROSE edited by CHARLES W. CALOMIRIS SERGIO L. SCHMUKLER RICHARD J. HERRING claudio borio, william curt hunter, JAIME CARUANA PATRICK HONOHAN HAL S. SCOTT george kaufman, and kostas tsatsaronis DANIEL COHEN PATRICIA JACKSON CLIFFORD W. SMITH JR. regulated industry. The chapters examine such topics CHRISTINE M. CUMMING MALCOLM KNIGHT SHYAM SUNDER The effectiveness of market discipline—the strong as the theory of market discipline, evidence of market FRANKLIN R. EDWARDS ANNE O. KRUEGER KOSTAS TSATSARONIS built-in incentives that encourage banks and financial discipline in banking and other industries, evidence of CHARLES M. ELSON EDUARDO LEVY-YEYATI INGO WALTER systems to operate soundly and efficiently—commands market discipline for countries, the current state of MARK J. FLANNERY DAVID T. LLEWELLYN EUGENE N.WHITE much attention today, particularly in light of recent corporate governance, and the interaction of market accounting scandals.As government regulation seems ROBERT P. FLOOD COLIN MAYER discipline and public policy. to grows less effective as the banking industry and financial markets grow more complex, the role of of related interest CLAUDIO BORIO is Head of Research and Policy market discipline becomes increasingly important. Analysis at the Bank for International Settlements in In this collection, which grew out of a conference Basel, Switzerland. ASSET PRICE BUBBLES borio cosponsored by the Federal Reserve Bank of Chicago THE IMPLICATIONS FOR MONETARY,REGULATORY,AND INTERNATIONAL POLICIES and the Bank for International Settlements in Basel, WILLIAM CURT HUNTER is Dean of the School hunter market discipline Switzerland, a diverse group of academics and policy- edited by William C. Hunter, George G. Kaufman, and Michael Pomerleano of Business at the University of Connecticut and former kaufman makers address different aspects of the ability of market Senior Vice President and Director of Research at the In the industrialized and developing world, a distinctive feature of the last two decades has been prolonged and discipline to affect corporate behavior and performance Federal Reserve Bank of Chicago. buildups and sharp collapses in asset markets such as stock, housing, and exchange markets.This book exam- across countries tsatsaronis and to regulate financial markets. ines asset price bubbles to further our understanding of the causes and implications of financial instability, GEORGE KAUFMAN is John F.Smith, Jr., Professor focusing on the potential of central banks and regulatory agencies to prevent it. EDITORS and industries A major purpose of the book is to develop evidence on of Economics and Finance at Loyola University in Chicago how market discipline operates across non-government and a consultant to the Federal Reserve Bank of Chicago. the MIT press regulated industries and in different countries, how 0-262-02575-2 edited by KOSTAS TSATSARONIS is Head of Financial MASSACHUSETTS INSTITUTE OF TECHNOLOGY successful it has been, and how it may transfer to a claudio borio, william curt hunter, Institutions and Infrastructures in the Research and Policy CAMBRIDGE, MASSACHUSETTS 02142 ,!7IA2G2-acfhfb!:t;K;k;K;k Analysis Division at the Bank for International Settlements. HTTP://MITPRESS.MIT.EDU george kaufman, and kostas tsatsaronis continued on back flap Market Discipline across Countries and Industries Market Discipline across Countries and Industries edited by Claudio Borio Bank for International Settlements William C. Hunter University of Connecticut and formerly Federal Reserve Bank of Chicago George G. Kaufman Loyola University Chicago and Federal Reserve Bank of Chicago Kostas Tsatsaronis Bank for International Settlements The MIT Press Cambridge, Massachusetts London, England © 2004 Massachusetts Institute of Technology All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission in writing from the publisher. MIT Press books may be purchased at special quantity discounts for business or sales promotional use. For information, please email [email protected] or write to Special Sales Department, The MIT Press, 5 Cambridge Center, Cambridge, MA 02142. This book was set in Times by the Federal Reserve Bank of Chicago and was printed and bound in the United States of America. Library of Congress Cataloging-in-Publication Data Market discipline across countries and industries / edited by Claudio Borio ... [et al.]. p. cm Papers presented at a conference cosponsored by the Federal Reserve Bank of Chicago and the Bank for International Settlements, held on Oct. 30 to Nov. 1, 2003, at the Federal Reserve Bank of Chicago. Includes index. ISBN 0-262-02575-2 (alk. paper) 1. Capital market—Congresses. 2. Internal finance—Congresses. 3. Banks and banking, International—Congresses. 4. Risk management— Congresses. I. Borio, C. E. V. HG4523.M267 2004 2004050028 332—dc22 Contents Acknowledgments ................................................................................................... ix Preface ..................................................................................................................... xi Part I: Keynote Addresses 1 Market Discipline and Public Policy: The Role of the IMF Anne O. Krueger ............................................................................................. 3 2 Three Observations on Market Discipline Malcolm Knight ............................................................................................. 11 3 Effective Market Discipline: The Roles of Auditors, Companies, and Analysts Susan Schmidt Bies ........................................................................................ 17 4 A Review of the New Basel Capital Accord Jaime Caruana ................................................................................................ 25 Part II: Theory of Market Discipline 5 Market Discipline: Players, Processes, and Purposes Robert R. Bliss ............................................................................................... 37 6 Market Discipline in Banking: Where Do We Stand? Jean-Charles Rochet ....................................................................................... 55 7 Market Discipline for Financial Institutions and Sovereigns Hal S. Scott ..................................................................................................... 69 8 Comments on the Theory of Market Discipline Kostas Tsatsaronis .......................................................................................... 79 vi Part III: Evidence of Market Discipline in Banking 9 Market Discipline of U.S. Financial Firms: Recent Evidence and Research Issues Mark J. Flannery and Stanislava Nikolova .................................................... 87 10 Bank Market Discipline and Indicators of Banking System Risk: The European Evidence Reint Gropp .................................................................................................. 101 11 Weakening Market and Regulatory Discipline in the Japanese Financial System Mitsuhiro Fukao ........................................................................................... 119 12 Market Discipline in Emerging Economies: Beyond Bank Fundamentals Eduardo Levy-Yeyati, Maria Soledad Martinez Peria, and Sergio L. Schmukler .............................................................................. 135 13 Inside the “Black Box” of Market Discipline David T. Llewellyn ....................................................................................... 147 Part IV: Evidence of Market Discipline in Other Industries 14 Market Discipline in Insurance and Reinsurance Scott E. Harrington ....................................................................................... 159 15 Conflicts of Interest and Market Discipline Ingo Walter ................................................................................................... 175 16 Market Discipline and Corporate Control Clifford W. Smith, Jr. ................................................................................... 187 Part V: Evidence of Market Discipline for Countries 17 Capital Controls: Mud in the Wheels of Market Discipline Kristin J. Forbes ........................................................................................... 197 18 Equity Integration in Times of Crisis Robert P. Flood and Andrew K. Rose .......................................................... 211 19 Assessing the Evidence on Market Discipline for Countries Andrew G. Haldane ...................................................................................... 225 vii Part VI: Current State of Corporate Governance 20 U.S. Corporate Governance: What Went Wrong and Can It Be Fixed? Franklin R. Edwards..................................................................................... 237 21 Corporate Governance in Europe: Competition versus Harmonization Marco Becht and Colin Mayer ....................................................................