The Program on the Law and Economics of Capital Markets
Funded by a generous grant from the NASDAQ OMX Educational Foundation
Market microstructure, the study of the economic forces affecting securities market trades, quotes and transaction prices, is a significant sub-field of financial economics. One principal focus concerns how the rules by which securities trade affect a market’s efficiency in terms of cost of operation, provision of liquidity and incorporation of new information into price. Notwithstanding this focus on rules, microstructure literature is largely uninformed about the real world regulatory structure within which securities markets operate. At the same time, the rather sparse legal literature concerning capital market regulation is largely confined to describing the institutional details of this regulatory structure and is little informed by the microstructure literature. This gap in the two literatures is particularly notable because there is extensive high quality scholarly literature on other aspects of securities regulation, much of which is significantly informed by financial economic principles.
To fill this gap, the Program on the Law and Economics of Capital Markets established a three-part project, jointly based at the Columbia Law School and Columbia Business School. First, we are developing a course, jointly listed at the two schools, devoted to the important legal and economic issues associated with capital markets. Second, we are conducting a series of events featuring a varied group of speakers - from the academy, law and financial practice, and government - who have expertise in the law and economics of capital markets. The attendees at these workshops - the Program Fellows - would be from a similarly mixed background. New York City, as the world’s financial capital, is the ideal venue for these workshops. Third, we are developing a textbook in the law and economics of capital markets that could be used as the teaching materials for similar courses at other universities as well as being a standard reference book for practitioners, regulators and academics. As the first such book, it would play an important role in defining the field.
A more detailed view of the substantive content of all three parts to the project can be seen from the structure of the course. Following an introductory section, in which talk about the “capital market industry” and its importance in facilitating the efficient provision of goods and services in the economy and allocation of risk, we discuss the various theories of market microstructure. This is followed by a discussion of the empirical evidence, with particular reference to the measured economic importance of the effects described in the theories. The discussion of the theory and empirics of microstructure self-consciously lays the groundwork for the next section of the course - regulatory issues. The current list of regulatory categories, in large part determined by current and past policy discussions within the SEC and Congress, includes: 1) The definition of an exchange; 2) the concept of self-regulatory obligations; 3) Quote transparency, trade transparency, quote consolidation and “best execution” requirements; 4) Insider trading; 5) Short sale restrictions and rules; and 6) Price manipulation. The final part of the course looks at broader regulatory questions and the future of capital markets, including “Who should regulate?” and “How should transnational transactions be regulated?”
The second part of the project - the series of events featuring speakers with expertise in the law and economics of capital markets - will build important bridges between scholars and the real world. Both the speakers and the attendees will be a mixed selection of influential persons from the academy, law and financial practice, and government. The resulting interactions will lead to substantial synergies. From the academy’s side, exposing leading law and finance scholars to the fascinating issues faced by capital market actors is likely to alter their research agendas. Specifically, this exposure should both increase the overall amount of study of capital market institutions and steer scholars working in the area to focus on more relevant issues. It will also improve the quality of this scholarship. Scholarly studies, both theoretical and empirical, inevitably require the use of assumptions. A better understanding of the experiences of real world capital market participants will sharpen the choice of assumptions employed.
From the side of the practitioners and regulators, learning what cutting edge scholars are discovering about the institutions that are the focus of the practitioners’ and regulators’ professional lives will increase their understanding of the consequences of their decisions. This increased understanding should both help them better achieve their individual goals and improve the overall functioning of capital markets. And obviously the more the research about which they learn is improved by the interactions contemplated here, the more useful this learning will be.
The primary vehicle for this interaction between scholars and the real world is a series of workshops numbering perhaps five per academic year. Each event will have a featured speaker who would lay out the topic to be discussed with a short presentation. The bulk of the time will be devoted to an open exchange of ideas since the goal of the workshops is to make the information flow two-way, with academics learning about institutions and the actual practice of finance and with legal and financial practitioners and regulators being exposed to the most current research. After two or three years of these workshops, we expect to have a much more refined sense of the most important issues. There should also have developed by then a new body of research stimulated by the project. At this point, we contemplate the possibility of a conference with much the same aims as the workshop series, but that would attract as attendees prominent scholars, practitioners and regulators nationally and worldwide.
The third part of the project is the development of teaching materials for other law and business schools. Our aim is to fully integrate financial decision making and regulatory practice with a textbook that explains and relates the important concepts from financial economics and law. Legal cases that have been influential in the interpretation of regulation and business cases that illustrate firm decision making in an environment of capital market regulation will be used to enhance student understanding of the legal and economic principles.
As an aid to research in the field of capital markets regulation, the Program has prepared three comprehensive annotated bibliographies surveying relevant statutes, rules, legislative history, SEC Releases, cases and scholarly and practitioner oriented articles, treaties and commentary. There are hyperlinks to most of the items in each bibliography. The fields covered are manipulation, clearing and settlement, and cross border exchange mergers (links to these bibliographies are located in the top-left navigation on this page).
This program is generously funded by a grant from the NASDAQ OMX Educational Foundation.