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.