Self-regulatory organizations under the shadow of governmental oversight : blossom or perish?

Abstract

Self-Regulatory Organizations (SROs) have been argued to be afflicted with incentive-incompatibility problems and, indeed, they have a mixed record in their ability to curb market abuse. An earlier theoretical study by DeMarzo et al. (2005), however, finds that SROs, under the oversight of the government, may overcome these incentive-incompatibility problems and may deliver the same degree of oversight as the government would have delivered without the SRO, but against lower costs. I find that this result hinges on the assumption that the interaction between the SRO and the government can be characterized as a game of sequential moves with the SRO moving first and the government moving second. For institutional settings where it is more appropriate to characterize the interaction as a game of simultaneous moves, I obtain the inefficient result that oversight by the government fully crowds out oversight by the SRO. A possible remedy is suggested.