THE VALUE OF REGULATORS AS MONITORS: EVIDENCE FROM BANKING

Abstract

While conventional wisdom suggests that regulation is costly for shareholders, agency theory predicts a positive role of regulation in reducing shareholder monitoring costs. I study this tradeoff by exploiting an unexpected decrease in small-bank reporting requirements to the Federal Reserve using a regression discontinuity design. Using the reporting change as a negative shock to regulatory monitoring by the Fed, I find that reduced Fed monitoring leads to a 1% loss in Tobin’s q and a 7% loss in equity market-to-book. I show that these losses come from increased internal monitoring expenditures, managerial rents, and monitoring conflicts between shareholders. My results are among the first to quantify the shareholder value of monitoring.