Saturday, February 16, 2013

Non Tobin

Three economists say, corporate governance will respond to incentives. They are Alex Edmans, Vivian W Fang and Emanuel Zur, but you have to think a second time to see why;
The stock market is a powerful tool for controlling corporations’ behaviour. But which is better, a highly liquid market or a number of large blockholders? This column argues in favour of liquidity. Evidence suggests that policymakers should not reduce stock liquidity through greater regulation [or a Tobin Tax]. While the idea that liquidity encourages short-term trading – rather than long-term governance – sounds intuitive, deeper analysis shows that liquidity is beneficial because it encourages large shareholders to form in the first place, and allows shareholders to punish underperforming firms through selling their stake.
After a lengthy analysis, they conclude;
...liquidity can be beneficial by encouraging large shareholders to form in the first place, and by allowing shareholders to punish an underperforming firm through selling their stake. More broadly, the paper contributes to a recent literature on the real effects of financial markets. The traditional view (e.g. Morck, Shleifer, and Vishny 1990) is that financial markets are simply a side-show that passively reflects firms’ fundamentals – for example, a fall in the stock price reflects a deterioration in firm performance. This newer literature, surveyed by Bond, Edmans, and Goldstein (2012), shows that stock prices actively affect a firm’s fundamentals – a fall in the stock price exerts governance on the manager by worsening his compensation and reputation; the threat of such a fall induces the manager to exert effort. Thus, policymakers should take into account the effects of financial markets on real economic activity when designing regulations.
Or, F.A. Hayek knew the Use of Knowledge in Society.  Yes, he did.

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