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Markets vs. Mechanisms

Author

Listed:
  • Raphael Boleslavsky

    (University of Miami)

  • Christopher Hennessy

    (London School of Economics)

  • David L. Kelly

    (University of Miami)

Abstract

We demonstrate constraints on usage of direct revelation mechanisms (DRMs) by corporations inhabiting economies with securities markets. We consider a corporation seeking to acquire decision relevant information. Posting a standard DRM in an environment with a securities market endogenously increases the outside option of the informed agent. If the informed agent rejects said DRM, then she convinces the market that she is uninformed, and she can trade aggressively sans price impact, generating large (off-equilibrium) trading gains. Due to this endogenous outside option effect, using a DRM to screen out uninformed agents may be impossible. Even when screening is possible, refraining from posting a mechanism and instead relying on markets for information is optimal if the endogenous change in outside option value is sufficiently large. Finally, even if posting a DRM dominates relying on markets, outcomes are improved by introducing a search friction, which randomly limits the agent’s ability to observe the DRM, forcing the firm to sometimes rely on markets for information.

Suggested Citation

  • Raphael Boleslavsky & Christopher Hennessy & David L. Kelly, 2017. "Markets vs. Mechanisms," Working Papers 2017-11, University of Miami, Department of Economics.
    • Handle: RePEc:mia:wpaper:2017-11
    as

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    File URL: https://www.herbert.miami.edu/_assets/files/repec/WP2017-11.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Market Microstructure; Mechanism Design Publication Status: Submitted;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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