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REVISION: A Regulator's Exercise of Career Option to Quit and Join a Regulated Firm's Management with Applications to Financial Institutions

Thu, 16 Feb 2017 08:44:18 GMT

Among the issues raised during post-mortem of the financial crisis of 2008 is regulatory capture and revolving doors for regulators and political operatives transitioning to lobbying firms or financial firms they once regulated. Several papers claim that this facilitated lax enforcement by regulators, and excessive risk taking by financial firms – key factors that led to the crisis. This paper fills a gap in the literature by posing the revolving door hypothesis in the context of managerial compensation, and labor market mobility, for regulators who design mechanism(s) that affect firm capital structure, and who subsequently exercise career options to quit and join firm management or a lobbying firm. Our theory predicts that regulatory signals embedded in firm capital structure provide a common thread between managerial compensation for former regulators, firm leverage, excessive volatility, and bankruptcy risk. We identify early warning signals for firm bankruptcy from critical time ...