Price of Regulations: Regulatory Costs and the Cross-section of Stock Returns

49 Pages Posted: 30 Sep 2020 Last revised: 4 Mar 2021

Date Written: March 4, 2021

Abstract

Regulations introduce significant fixed costs and add to operating leverage. Fixed regulatory costs that contribute to operating leverage should generate a risk premium. To explore whether such a premium exists, we introduce a measure of "regulatory operating leverage" that reflects the importance of fixed regulatory costs in a firm's cost structure. Regulatory operating leverage predicts stock returns in the cross-section, and a zero-cost high-low equal (value)-weighted regulatory operating leverage strategy generates 5.64% (5.28%) annualized risk-adjusted return. Finally, the impact of regulatory operating leverage on returns is due to the (systematic) risk contribution of fixed regulatory costs.

Keywords: Regulations, operating leverage, regulatory operating leverage, cross-section of returns, systematic risk

JEL Classification: G12, G18, G28

Suggested Citation

Ince, Baris and Ozsoylev, Han N., Price of Regulations: Regulatory Costs and the Cross-section of Stock Returns (March 4, 2021). Available at SSRN: https://ssrn.com/abstract=3655823 or http://dx.doi.org/10.2139/ssrn.3655823

Han N. Ozsoylev

Ozyegin University ( email )

Kusbakisi Cd. No: 2
Altunizade, Uskudar
Istanbul, 34662
Turkey

No contact information is available for Baris Ince

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