TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Monday, August 27, 2012

Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership

Jordan M. Barry (University of San Diego, School of Law), John William Hatfield (Stanford University, Graduate School of Business) & Scott Duke Kominers (University of Chicago, Becker Friedman Institute for Research in Economics), On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership:

The prevailing view among many economists is that derivatives markets simply enable financial markets to incorporate information better and faster. Under this view, increasing the size of derivatives markets only increases the efficiency of financial markets.

We present formal economic analysis that contradicts this view. Derivatives allow investors to hold economic interests in a corporation without owning voting rights, or vice versa. This leads to both empty voters — investors whose voting rights in a corporation exceed their economic interests — and hidden owners — investors whose economic interests exceed their voting rights. We show how, when financial markets are opaque, empty voting and hidden ownership can render financial markets unpredictable, unstable, and inefficient. By contrast, we show that when financial markets are transparent, empty voting and hidden ownership have dramatically different effects. They cause financial markets to follow predictable patterns, encourage stable outcomes, and can improve efficiency. Our analysis lends insight into the operation of securities markets in general and derivatives markets in particular. It provides a new justification for a robust mandatory disclosure regime and facilitates analysis of proposed substantive securities regulations.

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This is a prime example of the garbage that oozes out of universities as a result of the pressure to publish. The authors have hit upon an "issue" that the market already knows about and already prices in. Unless these tony academics believe that every trader is a monkey randomly yelling and bumping into things until these three arrive to sort them out (which is clearly what they believe), then we don't have a problem requiring yet another inadequate top-down solution by a group of academics pretending to at knowledge. It is obviously far too easy to get a Ph.D.

Posted by: Methinks | Aug 30, 2012 6:20:17 AM