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This essay discusses the economic case for regulating shadow banking. Focusing on systemic risk, shadow banking is defined as leveraging on collateral to support liquidity promises. Regulating shadow banking is efficient because of the negative externality stemming from systemic risk. However, because uncertainty undermines the precise measurement of systemic risk, quantity regulation is preferable to a Pigovian tax to cope with this externality. This paper argues that regulation should limit the leverage of shadow banking mainly by imposing a minimum haircut regulation on the assets being used as collateral for funding.
The euro area consists of 19 European states that share a single currency but lack a common fiscal policy. The European sovereign debt crisis of 2011-2012 revealed the fragility of this set-up, when distress in certain national debt markets hampered the transmission and the singleness of monetary policy, pushing the currency union to the brink of a break-up. Another related complication that came to the fore during the crisis was the interdependence between sovereigns and their banks. In the euro area, banks are heavily exposed to sovereigns, which means that shocks in the banking sector propagate to the sovereign and vice versa. This mechanism has been referred to as “doom loop”, “feedback loop”, or “sovereign-bank nexus”. Notwithstanding major efforts to revamp the supervisory and regulatory architecture, the doom loop is seemingly be alive and kicking.
A Legal Perspective on Technology and the Capital Markets: Social Media, Short Activism and the Algorithmic Revolution
In this essay, I examine the technological revolution in the capital markets through the normative lenses of law, policy and regulation. Do new media platforms necessarily enhance market efficiency? Or do they facilitate fraud and manipulation of stock prices? I focus on the rise of short activism on Twitter, Seeking Alpha and similar forms of social media: much like a stock promoter induces others to buy so he or she can sell at a profit, so a short activist might dupe others into selling so he or she can lock in profits before the stock rises again. Second, I examine the ways in which the rise of algorithmic trading shapes the emergence of accurate prices in the capital markets, from cybersecurity risk to limit order cancellations. There is growing evidence that prosecutors are taking technologically induced price distortions quite seriously. Finally, I consider emerging frontiers of technological innovation in the capital markets. The jury is still out on whether the benefits of digital ledger technology exceed the costs of the rampant investor deception which has led to a steady stream of crypto prosecutions and enforcement actions.
Debacles of historic dimensions tend to produce an excess of explanations. So has it been with Enron, as virtually every commentator has a different diagnosis and a different prescription. Yet, in most respects, Enron is a maddeningly idiosyncratic example of pathological corporate governance, which by itself cannot provide evidence of systematic governance failure. Properly understood, however, the Enron debacle furnishes a paradigm of « gatekeeper failure » – that is, of why and when reliance may not be justified on « reputational intermediaries, » such as auditors, securities analysts, attorneys, and other professionals who pledge their reputational capital to vouch for information that investors cannot easily verify. This comment shows that, during the 1990’s, the expected liability costs associated with gatekeeper acquiescence in managerial misbehavior went down, while the expected benefits went up – with the unsurprising result that earnings restatements and earnings management increased. Diagnosing the circumstances under which « gatekeeper failure » is likely leads in turn to prescriptions focused on re-aligning the incentives of gatekeepers with those of investors.
Behavioral finance is a relatively new but quickly expanding field that seeks to provide explanations for people’s economic decisions by combining behavioral and cognitive psychological theory with conventional economics and finance. Fueling the growth of behavioral finance research has been the inability of the traditional expected utility maximization of rational investors within the efficient markets framework to explain many empirical patterns. Behavioral finance attempts to resolve these inconsistencies through explanations based on human behavior, both individually and in groups. For example, behavioral finance helps explain why and how markets might be inefficient. After initial resistance from traditionalists, behavioral finance is increasingly becoming part of mainstream finance.
This paper explores the issue of “re-making” corporate law through the prism of the United Nations’ recent efforts at reducing legal obstacles experienced by micro, small and medium-sized enterprises in starting and scaling a business. In order to be successful, we recommend that the UN should go back to business fundamentals and should attempt to build from the ground up based on the real world needs of entrepreneurs, rather than work off already existing corporate legal systems. In this way, it is possible to engage in a more imaginative form of regulatory design in which a clear, open and preferential legal framework for stimulating innovation and business creation can be developed.
The Future as History : The Prospects for Global Convergence in Corporate Governance and Its Implications
What forces explain corporate structure and shareholder behavior? For decades this question has gone unasked, as both corporate law scholars and practitioners tacitly accepted the answer given in 1932 by Adolf Berle and Gardiner Means that the separation of ownership and control stemming from ownership fragmentation explained and assured shareholder passivity. Over this decade, however, corporate law scholars have recognized that this standard answer begs an essential prior question: if ownership fragmentation explains shareholder passivity, what explains ownership fragmentation? Although the Berle and Means model assumed that large-scale enterprises could raise sufficient capital to conduct their operations only by attracting a large number of equity investors, contemporary empirical evidence finds that, even at the level of the largest firms, dispersed share ownership is a localized phenomenon, largely limited to the United States and Great Britain. Not only does the latest comparative research demonstrate that concentrated, not dispersed, ownership is the dominant worldwide pattern, but in-depth studies of individual countries show that share-holder activism increases in direct proportion to ownership concentration. As a result, these findings, in turn, suggest that the conventional governance norms in the United States may be more the product of a path-dependent history than the « natural » result of an inevitable evolution toward greater efficiency.
This essay is a contribution to the forthcoming Oxford University Press Handbook of Corporate Law and Governance edited by Jeffery Gordon and Georg Ringe. In the 1960s and 1970s, corporate law and finance scholars recognized that neither discipline was doing a very good job of explaining how corporations were really structured and performed. For legal scholars, Yale Law School professor and then Stanford Law School dean Bayless Manning confessed that corporate law has “nothing left but our great empty corporation statutes -towering skyscrapers of rusted girders, internally welded together and containing nothing but wind.” Michael Jensen and William Meckling made a similar comment with respect to finance. The theory of the firm was an “empty box” or a “black box” that provided no theory about “how the conflicting objectives of the individual participants are brought into equilibrium.” The result of Jensen and Meckling’s seminal reframing of corporate law in agency cost terms, and so into something far broader than disputes over statutory language, was that both Manning’s empty skyscrapers and Jensen and Meckling’s empty box began to be filled. The essay proceeds by tracking how corporate law became corporate governance – from legal rules standing alone to legal rules interacting with non-legal processes and institutions – through three somewhat idiosyncratically chosen but nonetheless related examples of how we have come to usefully complicate the inquiry into the structures that bear on corporate decision-making and performance.
The chapters in this book were presented at a conference on “The ‘New’ Corporate Governance” held at the Washington University School of Law in St. Louis. The conference was sponsored and hosted by the Center for Interdisciplinary Studies, along with support from the Whitney R. Harris Institute for Global Legal Studies, both of which are housed at the Washington University School of Law. The conference was held in honor of Joel Seligman – to whom this book is dedicated – and the contributions he has made to the study of securities regulation and corporate governance during his distinguished career. Before becoming the President of the University of Rochester in 2005, Joel Seligman served as the Dean and Ethan A. H. Shepley University Professor at the Washington University School of Law. This book is part of broader work through the Project on Commercializing Innovation at Stanford University’s Hoover Institution, which studies the law, economics, and politics of the range of legal and business relationships that can be used to bring ideas to market. We thank James E. Daily, who is a Postdoctoral Fellow and Administrative Director of the Project, for his excellent help editing the manuscript. More about the Project is available on the Web at www.innovation.hoover.org.
The author’s goal in this Essay is to consider how theories of the corporation have developed and changed over the last hundred and fifty years. Based on this survey, the author offer some observations about the role of such theories in discourse about corporate law and corporate activity.