Toward a Benchmark for Optimal Prudency Policy.

This paper presents a benchmark model of prudency policy. The incidence and the financial implications of optimal prudence reviews are examined in a stylized setting. In the environment considered, prudence reviews optimally occur following particularly unfavorable performance by the regulated firm, and they impose expected penalties on the firm. However, rewards as well as penalties from prudence reviews are generally optimal. Furthermore, the risk and expected penalties associated with prudence reviews decline as the regulator's ex ante assessment of the firm's activities becomes more favorable. Copyright 1995 by Kluwer Academic Publishers