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The objectives of market regulation are to control fraud, control agency problems, promote fairness, set mutually beneficial standards, prevent undercapitalized financial firms from making excessively risky investments, and to ensure that long-term liabilities are funded.
As a market becomes more regulated, what would probably become more common?
- The collapse of financial firms.
- Insiders with an edge over other market participants.
- Conservative liability estimates by insurance companies and pension funds.
The correct answer is C.
Regulation should promote fairness and therefore reduce the advantage that insiders have over less sophisticated investors. Also, by preventing excessive risks, financial firms should have a higher margin of error and thus be less likely to become insolvent. Since unregulated insurance companies and pension funds have a tendency to utilize aggressive liability estimates (usually in order to maximize reported profit), more regulation would probably encourage these entities to become more conservative in their estimates.
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