When Good Intentions Go Wrong: Effects of Bank Deregulation and Governance on Risk-taking

The motivation of economic liberalization is to foster competition in order to increase allocative efficiency, economic growth and social welfare. This paradigm hinges on the assumption that firms maximize value and that more competitors in a market automatically lead to more competition. However, this view does not take into account the link between regulation and corporate governance, and its influence on firm behavior. When regulatory constraints are removed, the outcome may critically depend on the interaction between corporate governance and firm behavior, particularly if behavior is not primarily driven by value maximization and if the regulation had been designed to inhibit risk-taking.