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Information frictions between firms and regulators are typically seen as a means by which firms evade enforcement or, alternatively, a means through which they can limit rent-seeking behavior. In contrast, we argue that information frictions between firms and regulators reduce the efficiency of firms’ compliance efforts, particularly when industry rules are open-ended or qualitative. We use physical distance between firms and regulators to test these competing theories of information exchange on a panel of U.S. community banks between 2001 and 2010. We exploit overlapping regulatory jurisdictions to generate plausibly exogenous variation in distance between bank and supervisor. We find that banks located at a greater distance from regulatory field offices face significantly higher administrative costs, at an average rate of about 20% of administrative costs per hour of travel time. These cost differences are not accompanied by differences in compliance outcomes, are not driven by endogenous regulator choice, and are stable over our time period. Further, the inefficiency of distant firms is negatively related to the scale of the jurisdiction in which they operate, suggesting that information spillovers within jurisdictions limit the uncertainty about regulatory expectations in decentralized oversight regimes.
Regulatory oversight demands ongoing information exchange between firms and regulators. The dominant paradigm emerging from economic models of regulation sees this exchange in terms of monitoring and enforcement costs. It predicts that firms use information frictions to their advantage by reducing compliance efforts (Becker 1974, Laffont and Tirole 1993). Empirical support for these models is primarily drawn from contexts where governmental resources are limited and the mandate to enforce regulation is relatively weak. Likewise, the literature on crony capitalism tends to emphasize the rentseeking potential of relationships with government agents, particularly when rule of law is weak, access costs are low and government agents enjoy stable tenure (Stigler 1971). By and large, these theories see information exchange between firms and regulators as an adversarial process, and predict that information frictions allow firms or regulators to benefit at the expense of the public.
In contrast, we argue that information exchange between firms and regulators may also act as a channel for public-good provision. Information frictions between firms and regulators cause uncertainty for both parties that are costly to resolve. This uncertainty increases the cost of firms’ compliance efforts, particularly when industry rules are open-ended or qualitative. When regulators are relatively powerful and governed by strong rule of law, firms are likely to bear the cost of regulators’ uncertainty about firm behavior through demands for information. They will also bear the cost of their own uncertainty about regulatory expectations, through ineffective compliance efforts. In such environments, information exchange with regulators has the potential to be a cooperative process that benefits both firms and the public by reducing compliance costs without reducing compliance levels.
In other words, if uncertainty between firms and regulators is high, information frictions between firms and regulators should increase firms’ administrative and control costs without corresponding compliance improvements. This prediction stands in contrast to the standard theories: If frictions facilitate differential enforcement, they should be associated with decreased administrative and control costs, along with deteriorating compliance outcomes. If information frictions make rent-seeking more difficult, they may (or may not) be associated with administrative inefficiencies, but would certainly be associated with improved compliance outcomes.
This paper explores these competing views of information exchange with regulators and provides estimates of the efficiency costs of information frictions in the U.S. commercial banking industry. This setting has unique benefits for our identification strategy. First, a major challenge in identifying the impact of information exchange on firm performance is that these interactions are generally endogenous. For example, a direct measure of information sharing might be the number of phone calls or visits between firms and regulators, but these are likely to be driven by a firms’ economic condition. Instead, our study relies on exogenous variation in the cost of information exchange driven by geographic dispersion of firms and regulatory field offices. Multiple geographically overlapping regulatory jurisdictions operating under harmonized rules allow us to control for variation in firm performance associated with this geographic dispersion that is unrelated to regulatory enforcement. We also limit our sample to community banks, for which location decisions are driven by proximity to depositors and borrowers.
We find that physical proximity to regulatory field offices is beneficial to the firms under study: banks located at a smaller distance from field agencies face significantly lower administrative costs, at an average rate of about 20% of administrative costs per hour of travel time. This finding suggests the existence of costly uncertainty in the regulatory relationship. Further analysis reveals that these efficiency benefits are not due to differences in portfolio choices or risk taking, are not driven by endogenous regulator choice, and are stable over our time period. The administrative inefficiency of distant firms is negatively related to the scale of the jurisdiction in which firms operate, suggesting that information spillovers within jurisdictions limit the uncertainty about regulatory expectations in decentralized oversight regimes.
Our results have implications for our understanding of the value of firms’ government relationships, as well as for managers and policymakers. If regulatory monitoring results in an a higher compliance burden when information frictions are low, managers should adopt an arms-length approach to oversight relationships; if regulators provide resources, information or learning opportunities, a more collaborative stance is in managers’ interest. We provide novel evidence that a firm’s positioning vis-à vis regulatory agencies has the potential to create operational value for firms.
The implications for public policy are different from those derived from the literature that emphasizes conflict inherent in the regulatory relationship. Our results suggest that regulatory capacity creates positive spillovers that go beyond the execution of the regulatory mandate, but they also show that these interventions may create uneven access to such benefits within industry. While the value of regulatory relationships is certainly linked to the institutional context, such as the strength of regulators’ enforcement mechanisms and public accountability, efforts to minimize rent-seeking behavior by firms might limit the potential for value creation through public-good provision.
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