Responding to Regulatory Uncertainty: Evidence from Basel III

Abstract

This paper examines how firms respond to proposed regulation. Specifically, we utilize the time period over which banking authorities discussed, adopted, and implemented Basel III to examine how banks responded to the proposed regulatory framework. We find that banks were not only quick to lobby rule makers against the proposal, but that they also simultaneously altered their business models and made strategic financial reporting changes in response to it. We also provide evidence that banks were more likely to make these anticipatory changes when they: 1) benefitted more from signaling an early commitment, or 2) had less uncertainty about whether they would be subjected to the regulation. Taken together, our findings indicate that firms’ incentives lead them to simultaneously respond through multiple channels when faced with regulatory uncertainty.