Efficient Markets, Deficient Governance

Contents [hide] 1 Basic Information of Efficient Markets, Deficient Governance 2 Case Summary of Efficient Markets, Deficient Governance 3 Case Analysis of Efficient Markets, Deficient Governance 4 External Link of Efficient Markets, Deficient Governance 5 Relevent File Cabinet of Efficient Markets, Deficient Governance 6 Article Purchase Link of Efficient Markets, Deficient Governance

Basic Information of Efficient Markets, Deficient Governance

Author: Amar V. Bhide
Publisher: HBR
Case Number: 94602
Publication Date: Nov 1, 1994
Course Category: Management

Case Summary of Efficient Markets, Deficient Governance

U.S. stock markets—widely respected as broadest, most active, and fairest anywhere
Yet, system nurtures market liquidity at expense of good governance. Rules that protect integrity of markets also foster antagonism between shareholders and managers.
Extensive Web of Regulation
--passed Securities Act of 1933 and Securities Exchange Act and created the SEC in 1934
Protected investors before they incurred losses:
    A. Required issuers of securities to provide information about directors, officers, underwriters and large shareholders
    --penalties for false/misleading statements
---ð> to help investors make informed trading decisions
    B. Required every officer, director and 10% equity owner to report securities they owned
    --insiders had to turn over any short-term trading profits to company
---ð> to discourage insider trading
    C. Eliminated manipulation and sudden and unreasonable fluctuations of prices
    --no manipulation of prices or making of false statements
    --deregulating stock commissions (so brokerage fees fell quickly)
    --regulated financial institutions that managed funds
---ð> to protect investors

The Basis of Market Liquidity
--SEC reassures speculators by certifying the integrity of market exchanges
=> The more investors diversity => the more fragmented the stockholding of co. => promotes liquidity by increasing odds of a trade
--US has more regulations than our European counterparts

The Catch
--not only sustains market liquidity, BUT also drives wedge between shareholders and managers
--special restrictions on investors who hold more than 10% of stock, serve on board, or receive any insider info
--so institutional investors receive to receive any private info from managers
--market liquidity weakens incentives to be an insider
--free rider problem—oversight and counsel of 1 shareholder benefits everyone else
--allows investors to sell out quickly at less than a nickel in commissions
=> results in outsiders holding most of US stocks
--even today, investors act more like German and Japanese stockholders
--Berkshire Hathaway’s Warren Buffett—serves on boards of 9 companies that he
Invests in and will intervene to protect investments

The Effect of Governance
A. Basic nature of executive work calls for an intimate relationship between managers and stockholders
B. Managers have broad responsibility to act in best interests of stockholders
C. Shareholders must maintain candid, ongoing dialogue with managers (but impossible)
D. Managers cannot debate critical issues in public and insider trading prohibits private discussions
E. Managers have trouble advancing interests of the anonymous shareholder
 public equity markets are an unreliable source of capitalà managers and shareholders must regard each other with suspicion è
--companies issue equity to reduce their leverage in anticipation of increased risk
--during “windows of opportunity”, investors are able to trade “hot” stocks
 workings of a stock market that facilitates capital flows actually immobilizes capital within companiesà

The Limitations of External Discipline
--Raiders serve as a check only against incompetence and abuse
--outside shareholders and analysts cannot easily distinguish between CEO’s ability and luck
Reduced oversight by stockholders => better analysts reports and greater support for hostile takeovers

The Moral Consequences
--Fiduciaries have broad obligation to put clients’ interests ahead of their own
--There will always be rationalization of conflicts between moral values and shareholder wealth

The Case for Reform
BIG PROBLEM: ignorance of connections between investor protection, market liquidity and governance

Good governance requires real policy trade-offs.
--cannot just change the rules
--if inside stockholders could block acquisitions, many deals would disappear
More trust => opportunities for greater fraud

Better governance could unlock enormous value by reducing the invisible inefficiencies that external markets can’t detect.
--current system robs managers of the respect and approval of their shareholders