The Failure of Market Efficiency

Recent years have witnessed the near total triumph of market efficiency as a regulatory goal. Policymakers regularly proclaim their devotion to ensuring efficient capital markets. Courts use market efficiency as a guiding light for crafting legal doctrine. And scholars have explored in great depth the mechanisms of market efficiency and the role of law in promoting it. There is strong evidence that, at least on some metrics, our capital markets are indeed more efficient than they have ever been. But the pursuit of efficiency has come at a cost. By focusing our attention narrowly on economic efficiency concerns—such as competition, friction, and transaction costs—we have lost sight of other, deeper values within our economic system, including wider conceptions of duty, fairness, and morality. And while regulators sometimes pay lip service to these values, they often treat them as merely a subset of efficiency: the best way to treat investors fairly, to promote equality, and to prevent immoral, exploitative behavior, in this view, is simply to create an efficient market. We have seen the consequences of this emphasis play out in spectacular fashion in the last decade. New market structures and technologies—from special purpose acquisition companies to social-media oriented trading apps to cryptocurrencies—have emerged to eliminate barriers to trade and compete with institutional incumbents. These strategies may well lead to more efficient markets insomuch as they facilitate access to capital, but they also have the side effect of placing unsophisticated individuals into complex contractual arrangements with sophisticated market actors. The result is an “efficient” market, but one with steep moral and social costs. This Article examines the limits of market efficiency as a regulatory goal and suggests a set of structural and substantive reforms aimed at better balancing efficiency with the other goals of markets. It concludes that regulators, courts, and scholars alike need to adopt a more comprehensive understanding of the proper ends of market regulation, one that emphasizes the purpose and spirit of finance over the false promise of efficiency

The Failure of Market Efficiency

Recent years have witnessed the near total triumph of market efficiency as a regulatory goal. Policymakers regularly proclaim their devotion to ensuring efficient capital markets. Courts use market efficiency as a guiding light for crafting legal doctrine. And scholars have explored in great depth the mechanisms of market efficiency and the role of law in promoting it. There is strong evidence that, at least on some metrics, our capital markets are indeed more efficient than they have ever been. But the pursuit of efficiency has come at a cost. By focusing our attention narrowly on economic efficiency concerns—such as competition, friction, and transaction costs—we have lost sight of other, deeper values within our economic system, including wider conceptions of duty, fairness, and morality. And while regulators sometimes pay lip service to these values, they often treat them as merely a subset of efficiency: the best way to treat investors fairly, to promote equality, and to prevent immoral, exploitative behavior, in this view, is simply to create an efficient market. We have seen the consequences of this emphasis play out in spectacular fashion in the last decade. New market structures and technologies—from special purpose acquisition companies to social-media oriented trading apps to cryptocurrencies—have emerged to eliminate barriers to trade and compete with institutional incumbents. These strategies may well lead to more efficient markets insomuch as they facilitate access to capital, but they also have the side effect of placing unsophisticated individuals into complex contractual arrangements with sophisticated market actors. The result is an “efficient” market, but one with steep moral and social costs. This Article examines the limits of market efficiency as a regulatory goal and suggests a set of structural and substantive reforms aimed at better balancing efficiency with the other goals of markets. It concludes that regulators, courts, and scholars alike need to adopt a more comprehensive understanding of the proper ends of market regulation, one that emphasizes the purpose and spirit of finance over the false promise of efficiency

The Impossibility of a Perfectly Competitive Labor Market

Using the institutional theory of transaction cost, I demonstrate that the assumptions of the competitive labor market model are internally contradictory and lead to the conclusion that on purely theoretical grounds a perfectly competitive labor market is a logical impossibility. By extension, the familiar diagram of wage determination by supply and demand is also a logical impossibility and the neoclassical labor demand curve is not a well-defined construct. The reason is that the perfectly competitive market model presumes zero transaction cost and with zero transaction cost all labor is hired as independent contractors, implying multi-person firms, the employment relationship, and labor market disappear. With positive transaction cost, on the other hand, employment contracts are incomplete and the labor supply curve to the firm is upward sloping, again causing the labor demand curve to be ill-defined. As a result, theory suggests that wage rates are always and everywhere an amalgam of an administered and bargained price. Working Paper 06-0

Newsletter / House of Finance, Goethe-Universität Frankfurt 4/10

Credit Rating Announcements – The Impact of the Agency’s Reason, Public Information, and M&A ; Toward a New European Financial Architecture in the Rating Sector – an Economic Analysis and Legal Solutions ; Where Finance Meets Macro ; Clear Enforcement rules for the Stability and Growth Pac

Competition and Stability in Banking

I review the state of the art of the academic theoretical and empirical literature on the potential trade-off between competition and stability in banking. There are two basic channels through which competition may increase instability: by exacerbating the coordination problem of depositors/investors on the liability side and fostering runs/panics, and by increasing incentives to take risk and raise failure probabilities. The competition-stability trade-off is characterized and the implications of the analysis for regulation and competition policy are derived. It is found that optimal regulation may depend on the intensity of competition.antitrust, regulation, crisis, risk-taking, mergers, state aid, bail-outs

Examined Lives: Informational Privacy and the Subject as Object

In the United States, proposals for informational privacy have proved enormously controversial. On a political level, such proposals threaten powerful data processing interests. On a theoretical level, data processors and other data privacy opponents argue that imposing restrictions on the collection, use, and exchange of personal data would ignore established understandings of property, limit individual freedom of choice, violate principles of rational information use, and infringe data processors\u27 freedom of speech. In this article, Professor Julie Cohen explores these theoretical challenges to informational privacy protection. She concludes that categorical arguments from property, choice, truth, and speech lack weight, and mask fundamentally political choices about the allocation of power over information, cost, and opportunity. Each debate, although couched in a rhetoric of individual liberty, effectively reduces individuals to objects of choices and trades made by others. Professor Cohen argues, instead, that the debate about data privacy protection should be grounded in an appreciation of the conditions necessary for individuals to develop and exercise autonomy in fact, and that meaningful autonomy requires a degree of freedom from monitoring, scrutiny, and categorization by others. The article concludes by calling for the design of both legal and technological tools for strong data privacy protection

Individual vs. Collective Bargaining in the Large Firm Search Model

We analyze the welfare and employment effects of different wage bargaining regimes. Within the large firm search model, we show that collective bargaining affects employment via two channels. Collective bargaining exerts opposing effects on job creation and wage setting. Firms have a stronger incentive for strategic employment, while workers benefit from the threat of a strike. We find that the employment increase due to the strategic motive is dominated by the employment decrease due to the increase in workers' threat point. In aggregate equilibrium, employment is ineciently low under collective bargaining. But it is not always true that equilibrium wages exceed those under individual bargaining. If unemployment benefits are sufficiently low, collectively bargained wages are smaller. The theory sheds new light on policies concerned with strategic employment and the relation between replacement rates and the extent of collective wage bargaining

Putting Theory into Practice: Market Failure and Market Based Instruments (MBIs)

The use of market-based instruments (MBIs) to provide and protect ecosystem services has gained significant attention in Australia. Despite their popularity, MBIs are not appropriate for the provision of all ecosystem services. Rather, MBIs must be carefully designed given the ecosystem service outcomes desired, while meeting the needs of participants. In this paper we detail the importance of a robust theoretical structure to underpin the selection and design of an MBI. In particular, we demonstrate the role of identifying and analysing the nature of the market failures present, and their implications for instrument design. Our conclusions are illustrated using several regional MBI case studies.Market Based Instruments (MBIs), ecosystem services, conservation