Market Efficiency after the Financial Crisis: It's Still a Matter of Information Costs

Compared to the worldwide financial carnage that followed the Subprime Crisis of 2007–2008, it may seem of small consequence that it is also said to have demonstrated the bankruptcy of an academic financial institution: the Efficient Capital Market Hypothesis (“ECMH”). Two things make this encounter between theory and seemingly inconvenient facts of consequence. First, the ECMH had moved beyond academia, fueling decades of a deregulatory agenda. Second, when economic theory moves from academics to policy, it also enters the realm of politics, and is inevitably refashioned to serve the goals of political argument. This happened starkly with the ECMH. It was subject to its own bubble—as a result of politics, it expanded from a narrow but important academic theory about the informational underpinnings of market prices to a broad ideological preference for market outcomes over even measured regulation. In this Article we examine the Subprime Crisis as a vehicle to return the ECMH to its information cost roots that support a more modest but sensible regulatory policy. In particular, we argue that the ECMH addresses informational efficiency, which is a relative, not an absolute measure. This focus on informational efficiency leads to a more focused understanding of what went wrong in 2007–2008. Yet informational efficiency is related to fundamental efficiency—if all information relevant to determining a security’s fundamental value is publicly available and the mechanisms by which that information comes to be reflected in the security’s market price operate without friction, fundamental and informational efficiency coincide. But where all value-relevant information is not publicly available and/or the mechanisms of market efficiency operate with frictions, the coincidence is an empirical question both as to the information efficiency of prices and their relation to fundamental value. Properly framing market efficiency focuses our attention on the frictions that drive a wedge between relative efficiency and efficiency under perfect market conditions. So framed, relative efficiency is a diagnostic tool that identifies the information costs and structural barriers that reduce price efficiency which, in turn, provides part of a realistic regulatory strategy. While it will not prevent future crises, improving the mechanisms of market efficiency will make prices more efficient, frictions more transparent, and the influence of politics on public agencies more observable, which may allow us to catch the next problem earlier. Recall that on September 8, 2008, the Congressional Budget Office publicly stated its uncertainty about whether there would be a recession and predicted 1.5 percent growth in 2009. Eight days later, Lehman Brothers had failed, and AIG was being nationalized

The New Business Entities in Evolutionary Perspective

The many legal forms for business organizations that first appeared in the U.S. during the last thirty years - the Limited Liability Company (LLC), the Limited Liability Partnership (LLP), the Limited Liability Limited Partnership (LLLP), and the statutory Business Trust - all combine the pattern of creditors' rights, or asset partitioning, that is traditional to the business corporation with the freedom of contract among investors and managers that is traditional to the partnership. To view these new entities as partnership-like is to treat the degree of freedom of contract as the essential difference between the traditional corporation and partnership forms; to view them as corporation-like is to treat the pattern of creditors' rights as the essential difference. While recent scholarship often takes the former view, the latter seems more accurate. History shows that much of the contractual inflexibility in the traditional corporation served merely to buttress its pattern of creditors' rights, and that this inflexibility fell away upon the development of substitute sources of investor protection. The new forms are thus better understood as part of a continuing development of the corporate form rather than as entities more akin to the traditional partnership, which has in fact been evolving in a different direction. The essay first develops this argument in terms of the tradeoff between contractual freedom and the form of asset partitioning that to date has received the most scholarly attention - that is, limited liability. It then explores the evolution of the new forms from a less familiar perspective, focusing on the entity shielding component of asset partitioning

Brief of Corporate Law Professors as Amici Curie in Support of Respondents

The Supreme Court has looked to the rights of corporate shareholders in determining the rights of union members and non-members to control political spending, and vice versa. The Court sometimes assumes that if shareholders disapprove of corporate political expression, they can easily sell their shares or exercise control over corporate spending. This assumption is mistaken. Because of how capital is saved and invested, most individual shareholders cannot obtain full information about corporate political activities, even after the fact, nor can they prevent their savings from being used to speak in ways with which they disagree. Individual shareholders have no “opt out” rights or practical ability to avoid subsidizing corporate political expression with which they disagree. Nor do individuals have the practical option to refrain from putting their savings into equity investments, as doing so would impose damaging economic penalties and ignore conventional financial guidance for individual investors

Ernst Freund as Precursor of the Rational Study of Corporate Law

Gindis, David, Ernst Freund as Precursor of the Rational Study of Corporate Law (October 27, 2017). Journal of Institutional Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2905547, doi: https://dx.doi.org/10.2139/ssrn.2905547The rise of large business corporations in the late 19th century compelled many American observers to admit that the nature of the corporation had yet to be understood. Published in this context, Ernst Freund's little-known The Legal Nature of Corporations (1897) was an original attempt to come to terms with a new legal and economic reality. But it can also be described, to paraphrase Oliver Wendell Holmes, as the earliest example of the rational study of corporate law. The paper shows that Freund had the intuitions of an institutional economist, and engaged in what today would be called comparative institutional analysis. Remarkably, his argument that the corporate form secures property against insider defection and against outsiders anticipated recent work on entity shielding and capital lock-in, and can be read as an early contribution to what today would be called the theory of the firm.Peer reviewe

Towards an Economy of Higher Education

This paper draws a distinction between ways thinking and acting, and hence of policy and practice in higher education, in terms of different kinds of economy: economies of exchange and economies of excess. Crucial features of economies of exchange are outlined and their presence in prevailing conceptions of teaching and learning is illustrated. These are contrasted with other possible forms of practice, which in turn bring to light the nature of an economy of excess. In more philosophical terms, and to expand on the picture, economies of excess are elaborated with reference, first, to the understanding of alterity in the work of Emmanuel Levinas and, second, to the idea of Dionysian intensity that is to be found in Nietzsche. In the light of critical comment on some current directions in policy and practice, the implications of these ways of thinking for the administrator, the teacher and the student in higher education are explored

Concluding Remarks on Creditor Protection

Summarizing the many thoughtful papers presented at this conference is a difficult task for an outside observer of European law reform. In lieu of bad comments on good papers, I offer instead my own observations on several of the conference's principal themes

Law and the Rise of the Firm

Organizational law empowers firms to hold assets and enter contracts as entities that are legally distinct from their owners and managers. Legal scholars and economists have commented extensively on one form of this partitioning between firms and owners: namely, the rule of limited liability that insulates firm owners from business debts. But a less-noticed form of legal partitioning, which we call "entity shielding," is both economically and historically more significant than limited liability. While limited liability shields owners' personal assets from a firm's creditors, entity shielding protects firm assets from the owners' personal creditors (and from creditors of other business ventures), thus reserving those assets for the firm's creditors. Entity shielding creates important economic benefits, including a lower cost of credit for firm owners, reduced bankruptcy administration costs, enhanced stability, and the possibility of a market in shares. But entity shielding also imposes costs by requiring specialized legal and business institutions and inviting opportunism vis-a-vis both personal and business creditors. The changing balance of these benefits and costs helps explain the evolution of legal entities across time and societies. To both illustrate and test this proposition, we describe the development of entity shielding in four historical epochs: ancient Rome, the Italian Middle Ages, England of the 17th-19th centuries, and the United States from the 19th century to the present