Regulations in Two Lemon Markets: An Application in Cross-Border Listing

I analyze a model where two independent regulators in two open economies strategically set regulatory stringency in their domestic lemon market. Since firms are allowed to enter either market, foreign regulation affects domestic firms’ outside options. I then link the regulations to the fundamentals of the two economies. When the difference in fundamentals between the two economies is moderate, there exists an equilibrium in which the strong economy has stricter regulation than the weak economy, and the good firms in the weak economy flow to the strong economy to signal for their type. When the difference in fundamentals between the two economies is either too large or too small, the equilibrium outcome is the same as the case when both economies are closed. In terms of global welfare, there exist inefficient regions of fundamentals where the strong economy under-regulates, while the weak economy over-regulates. ∗The author is from the University of Pennsylvania, Wharton School, Finance Department. I am grateful to Franklin Allen, Vincent Glode, Itay Goldstein, Doron Levit, Karen K. Lewis and Sophie Moinas for helpful comments. All errors are mine. Address for correspondence: 3620 Locust Walk, 2332 Steinberg Hall/Dietrich Hall, Philadelphia, PA 19104. Email: [email protected]