University of South Carolina School of Law
Evaluating Stock-Trading Practices and Their Regulation
The social benefits of more accurate stock prices—that is, stock-market prices that more accurately reflect the future cash flows that companies are likely to produce—are well established. But it is also thought that market forces alone will lead to only a sub-optimal level of stock-price accuracy—a level that fails to obtain the maximum net social benefits, or wealth, that would result from a higher level. One of the principal aims of federal securities law has therefore been to increase the extent to which the stock prices of the most important companies in our economy (public companies) contain information about firms’ prospects so that society generates more wealth. Indeed, enhancing the accuracy of these prices in this way is perhaps the primary justification for the corporate disclosure, fraud, and insider-trading rules that make up the traditional core of federal securities law. Yet, important price-accuracy effects of a distinct area of the field (the law governing the market in which stocks are traded) have been overlooked.
This Article theorizes that a set of central, yet little-noticed, stock-market rules is resulting in society producing a lower level of stock-price accuracy than it otherwise might. The Article therefore provides examples of ways in which the laws governing stock trading can be altered to increase stock-price accuracy. And it urges regulators to consider whether such alternations might be socially desirable in one of two ways: by enhancing the current level of stock-price accuracy in a manner that results in net social benefits, or by providing society with a lower-cost means than those associated with existing disclosure, fraud, and insider-trading laws for obtaining that current level. Accordingly, the Article theorizes that regulators have a fourth main securities-law tool (stock-market law) for increasing the accuracy of public companies’ stock prices, and sets forth a cost-benefit framework to help them determine whether it can be used to achieve one of the chief goals of securities law: obtaining a socially optimal level of stock-price accuracy.
Scholars and lawmakers have long touted the social benefits of public-company stock prices that more accurately reflect the future cash flows that those companies are likely to produce. This type of enhanced stock-price accuracy, they assert, aids society by leading to improved capital allocation and corporate governance. But those who impound information about firms’ prospects into stock prices are unable to capture the full amount of these social benefits that result from their efforts. This inability, in turn, leaves the vast beneficiaries of better resource allocation and firm management on their own to band together in a collective effort to make stock prices more accurate—something they cannot efficiently do. For these reasons, market forces alone are thought to lead only to a suboptimal level of stock-price accuracy—that is, a level that fails to obtain net social benefits, or welfare, that would result from a higher level. One of the principal aims of securities law is therefore to get more information about firms’ prospects into stocks’ market prices so that society generates more wealth. However, work in this area has overwhelmingly focused on the corporate disclosure, fraud, and insider-trading laws that compose the core of a typical Securities Regulation class. And important price-accuracy effects of a distinct area of the field (the law governing the market in which stocks are traded) have gone unnoticed.