Does regulation substitute or complement governance?

We examine whether firms utilize governance systems and increased monitoring mechanisms when information asymmetry and managerial discretion are limited. Given that such monitoring is costly, we expect regulated firms to use less monitoring if regulation substitutes for governance. Using data from initial public offerings, we document that regulated firms have greater proportions of monitoring directors and larger boards as well as use similar amounts of equity-based compensation as non-regulated firms. Further, regulated and unregulated firms are analogous in terms of observed trade-offs between traditional monitoring mechanisms and insider ownership. Finally, regulated firms appear to decrease monitoring following a period of deregulation. These findings support the hypothesis that regulation and governance are complements and are consistent with the notion that regulators pressure firms to adopt effective monitoring structures.