Fraud on the market: A relational investment approach

This article studies a previously unknown asset market in eighteenth-century Sweden. It emerged as a result of a partial default in 1719, when large amounts of recently released fiat coins were converted into government liabilities. These could only be redeemed as a customs duty on international trade, the licent. As merchants had to acquire such assets to conduct their trade, tens of thousands of transactions were carried out on a secondary market over a period of more than 45 years. Networks of local merchants bought assets from initial holders and sold them on to intermediaries or merchants, who deposited the liabilities with a newly established government agency, the Debt Office. Here, hundreds of account holders could transfer the value of their deposits between them. When a licent payment was due, the amount was deducted from the merchant's account. Prices on the liabilities were low and sometimes volatile, but the long-term trend was rising. We have distinguished three types of market participants: a small group of very active users, most of them professional dealers or brokers; merchants who traded on a regular basis as they needed to pay the licent, or when a favorable opportunity appeared; and finally, those who traded sporadically. The emergence of this market was part of a financial expansion that occurred in many European countries at the same time, the closest equivalent being the segmented default in France after the abolition of John Law's system. This study aims to broaden our understanding of eighteenth-century financial developments, which have rarely been studied in a semi-peripheral European economy.

Social and economic activities, like religion, entertainment, education, research, and the production of other goods and services, are carried on by different types of organizations, for example, corporations, proprietorships, partnerships, mutuals and nonprofits. There is competition among organizational forms for survival. The form of organization that survives in an activity is the one that delivers the product demanded by customers at the lowest price while covering costs. The characteristics of residual claims are important both in distinguishing organizations from one another and in explaining the survival of organizational forms in specific activities. This paper develops a set of propositions that explaim the special features of the residual claims of different organizational forms as efficient approaches to controlling agency problems. © M. C. Jensen and E. F. Fama, 1983 Michael C. Jensen, Foundations of Organizational Strategy Chapter 6, Harvard University Press, 1998. Journal of Law & Economics, Vol XXVI (June 1983) This document is available on the Social Science Research Network (SSRN) Electronic Library at: http://papers.ssrn.com/sol3/paper.taf?ABSTRACT_ID=94032 AGENCY PROBLEMS AND RESIDUAL CLAIMS

Canada's legal culture is a mixed legal culture, encompassing both the common law tradition inherited from England, and the civil law tradition, which connects Canada to its roots in Continental Europe. This mixed legal culture has come to be known as bijuralism. Inevitably, the presence of two legal cultures or traditions on Canadian soil means that they often come into contact with one another; the interaction of concepts, values and practices expressed in each of those legal traditions results in a true conversation of cultures. I will suggest that broader insight can be drawn from the conversation of Canada's legal cultures, insight that may be helpful in other contexts in which a plurality of cultures or systems of values and norms interact in a sustained manner, within a single space. I begin by explaining how Canada came to encompass both the civil and common law traditions and how Canada's federal system affects the conversation between these legal cultures. I will then consider the three possible modes of interaction that are possible where legal traditions, cultures, religions, or any other set of norms and values coexist, wrestle or clash in the same space: denial of plurality, which leads to the silencing of the minority tradition; acknowledgement of plurality, which requires one to create a space for each tradition; and embracing plurality, which treats the conversation of cultures less as a challenge than as a gift. I will examine how patterns reflecting each of these modes of interaction have repeated themselves, concluding that despite the unquestionable challenges posed by plurality, there is hope for a fruitful embrace of competing visions which must surely yield better self-knowledge and peaceful coexistence. Canada's Experience of Bijuralism The Roots of Bijuralism in Canada The common and civil law traditions can be distinguished generally on the basis of a few defining characteristics. Historically, the civil law tradition arose in Continental Europe, and traces its origins back to a revival of Roman law that took place between the twelfth and sixteenth centuries. It is characterised by a faith in written law, often manifest in the presence of a Civil Code, in which ordinary rules relating to family, property, contracts and wrongdoings, successions and other such topics - the rules of private law - are expressed in general language, arranged systematically. It is a legal tradition that accords primacy to the sovereign in the act of stating the law (Watkin 1999). As a result, judges in civil law countries typically deny that they are making law when they decide cases. By way of contrast, the common law tradition finds its roots in Great Britain in the eleventh century (Belanger-Hardy and Grenon 1997). It underlies the legal systems of the United Kingdom and the United States, as well as Commonwealth countries around the world. It is characterised by the special authority given to concepts and principles developed over time by judges deciding particular cases and, as a result, by the emphasis on unwritten law and incremental conceptions of the quest for justice (Glenn 2004). While problems in the two legal traditions often reach very similar solutions, one can see from this brief sketch that they operate under very different assumptions about, among other things, the role of legislatures, the role of judges, and the optimal mode of expression of legal norms. Civil law and common law are different legal cultures in that sense. They are two different languages which communicate differently within the law. How is it, then, that Canada came to house these two Western legal cultures? The early history of Canada, as is well known, is a mixture of settlement and conquest. In a land occupied by our First Nations, portions of Canada were settled by British subjects, who were presumed to have brought the common law tradition with them (Hogg 2002). However, what is now referred to as Central Canada was originally settled by the French, who established the civil law Custom of Paris as the principal set of legal norms in New France (Dickinson 2001). …

For years, commentators have debated how to reform the controversial Rule 10b-5 class action, without pausing to ask whether the game is worth the candle. Is private enforcement of Rule 10b-5 worth preserving, or might we be better off with exclusive public enforcement? This fundamental and neglected question demands attention today more than ever. An academic consensus has now emerged that private enforcement of Rule 10b-5 cannot be defended on compensatory grounds, at least in its most common form (a fraud-on-the-market class action brought against a non-trading issuer). That leaves the oft-cited, but under-theorized, rationale that private enforcement is a necessary supplement to the securities fraud deterrence efforts of the SEC. When this justification is critically examined, however, it proves to be highly debatable. A rich body of law and economics scholarship teaches that bounty hunter enforcement of an overbroad law, like Rule 10b-5, may lead to overdeterrence and stymie governmental efforts to set effective enforcement policy (even assuming away strike suits and the agency costs that attend class action litigation); if private enforcement is nevertheless desirable - a contestable proposition - it is because a world without it might result in even greater deviations from optimal deterrence, due to SEC budgetary constraints, inefficiency and/or capture. By carefully explicating the relative advantages and disadvantages of private Rule 10b-5 enforcement versus exclusive public enforcement, this Article reveals a new and better way to remedy the shortcomings of the Rule 10b-5 class action. It proposes that policymakers adopt an oversight approach to securities litigation reform by, for example, granting the SEC the ability to screen which Rule 10b-5 class actions may be filed, and against whom. By muting the overdeterrence threat of private litigation and placing the SEC back firmly at the helm of Rule 10b-5 enforcement policy, this approach would mitigate the primary disadvantages of private enforcement. Moreover, by preserving a private check on SEC inefficiency and capture and allowing the SEC to continue to supplement its budget with private enforcement resources, it would do so without eliminating the primary advantages of the current system. This approach stands in stark contrast to prior securities litigation reforms, which have responded to the overdeterrence threat posed by Rule 10b-5 class actions by rigidly narrowing the scope of private liability. This Article argues that an oversight approach to securities litigation reform carries distinct advantages over this narrowing approach, and ought to receive serious consideration in the ongoing policy debate.

The purpose of this study is to bring some insights from the civil law tradition to the corporate debate on asset partitioning, which has developed over the last decade in the common law literature. Exposing common law scholars to legal solutions that are rooted in civil law systems has the potential to transform the traditional approach taken by comparative civil law scholars in this field. In fact, it is a well-known fact that civil law scholars have produced an extensive body of literature on the feasibility of transplanting one of the most successful products of equity - trust law - to the civil law tradition. In comparative law study, the possibility that the common law legal system could benefit from solutions developed under the civil law tradition with respect to the partioning of assets has been essentially overlooked. Therefore, the purpose of this research is to create a two-way dialogue between the common law and civil law traditions regarding this particular area of law, and to reveal efficient solutions developed in continental Europe.Asset partitioning can be defined either as the segregation of an owner’s assets from a firm’s creditors, or the segregation of an organization’s assets from its owners’ personal creditors. The latter aspect, in particular, has been emphasized by H. Hansmann and R. Kraakman, who suggest that an organization is truly characterized by such a protection of its assets. These authors have noticed that this legal effect cannot be effectively achieved by contract alone, and that a special rule of law is necessary in order to exclude claims by owners’ personal creditors on a firm’s assets without those creditors’ consent. This study aims to identify, from a functional perspective, the costs and benefits of different legal substitutes used to partition assets. The comparative analysis of these various partitioning devices is being conducted in order to help understand the economics of achieving affirmative asset partitioning through the creation of a new legal entity, as opposed to doing so through a property law which grants asset separateness within the boundaries of the same entity.While American legal scholars conceive asset partitioning exclusively through the formation of a new legal entity, the civil law tradition allows this legal effect to be achieved within the boundaries of the same legal subject, thereby avoiding the creation of multiple legal entities.The tentative thesis of this study is that in the former system (common law), there is a sharp trade-off between the costs avoided due to asset partitioning (e.g. lower monitoring costs for specialized creditors), and the benefits lost by not having legal integration take place within a single entity (e.g. information economies of scale). In contrast, the asset separateness doctrine of the civil law tradition, by allowing a legal subject to partition these assets not only outside but also within the boundaries of the same legal subject, successfully overcomes this trade-off.The analysis is organized as follows. Part I provides a description of the current debate on asset partitioning in the U.S. Part II describes the doctrine of “asset separateness” rooted in the civil law tradition. Part III provides the historical evolution of asset partitioning in civil and common law traditions. Part IV examines the costs and benefits of civil and common law regulations on asset partitioning, with regard to different business transactions (including asset securitization and the organization of a mutual fund). Part V offers concluding remarks describing how financial transactions are the driving power behind the current convergence between civil and common law traditions on asset partitioning.

THIS spring the Supreme Court rejected a claim that the anti-fraud provisions of the Securities Exchange Act' impose a general fiduciary duty on those who control a corporation to act fairly toward minority interests.2 This decision, rejecting attempts to expand federal authority over internal corporate affairs through interpretation and thereby limiting the federal role to preventing fraud in securities transactions, may well increase the demands for major federal regulatory legislation governing the shareholdercorporation relationship. It is almost universally the opinion of academic commentators that state corporation codes do not impose sufficiently stringent controls on corporate management and are lax in protecting shareholders. Only federal intervention, it is said, can correct this sorry situation. This article will test the intellectual underpinnings of the conventional wisdom and of the rather venerable proposals calling for the federal regulation of the governance of corporations3 against an economic theory of corporate function and control. It will conclude both that state corporate legal systems are

This doctoral dissertation seeks to improve the usage of direct democracy in order to minimize agency cost. It first explains why insights from corporate governance can help to improve constitutional law and then identifies the relevant insights from corporate governance that can make direct democracy more efficient. To accomplish this, the dissertation examines a number of questions. What are the key similarities in corporate and constitutional law? Do these similarities create agency problems that are similar enough for a comparative analysis to yield valuable insights? Once the utility of corporate governance insights is established, the dissertation answers two questions. Are initiatives necessary to minimize agency cost if referendums are already provided for? And, should the results of direct democracy be binding in order for agency cost to be minimized? This comparative analysis is valuable because no existing research can be found which uses corporate governance to draw insights that can minimize agency cost in constitutional law, particularly by improving the use of direct democracy. After having explained the theoretical framework, this dissertation looks at circumstances where the right to veto (e.g. referendums) cannot help principals to reduce agency cost. Building on the corporate governance debate, this dissertation argues that introducing initiatives in constitutional law can reduce agency cost by separating individual issues from general elections. It also argues that giving legislators exclusive control of the agenda can, over the course of decades, lead to a situation where legislators accumulate more authority than citizens wish to delegate. Because initiatives also carry the risk of diluting the accountability and responsibility of the legislators, the dissertation proposes a system of ‘penalty defaults’ in favor of initiatives. By creating a default restrictive on legislators (namely a default rule allowing for initiatives), the constitution can ensure that initiatives are possible in the normal situation in which they actually reduce agency cost. At the same time, legislators are well situated to push for an end to the use of initiatives if they are being abused too frequently. The dissertation then argues that referendums should be binding on the legislature in two cases: one, when they relate to ‘rules of the game’ decisions; and two, when the legislators 283 have a conflict of interest. This is based on insights from the almost universally accepted right of shareholders to approve or reject fundamental corporate decisions initiated by the board of directors or whenever they have a conflict of interest. The last issue covered by the present work is whether or not initiatives should be binding in order to minimize agency cost. The U.S. and the UK have both been successful in attracting investors and managerial talent despite considerable differences in the ability of shareholders to initiate decisions. In light of this, these two legal systems and the pertinent academic literature on corporate governance are examined in order to identify when initiatives should be binding in order to minimize agency cost. Based on this analysis, it is argued that binding initiatives should only be allowed for making ‘rules of the game’ decisions especially when the legislators have a conflict of interest. Interestingly, this dissertation recommends that initiatives should also be allowed on ‘ordinary business decisions’, but such initiatives should be non-binding in order to minimize agency cost.

Over the last decade, missions of the UN have assisted with constitutional reforms including issues of federalism. The hopes for peace with regard to federal structures have often failed. This paper elaborates possible reasons why these hopes were disappointed. It will show that one should understand the differences between Common Law and continental systems with regard to federalism. Some experts from Common Law countries fail to appreciate the substantial difference between federal Constitutions embedded in a Civil Law culture and those embedded in a Common Law culture. The reasons for the success or failure of past, present and future federal reforms may help to improve UN activities in this field. States of the Common Law tradition are not collective units, which have to steer their society. The Jacobins of the French Revolution, considered the State as their instrument to transform feudal society into a society of equal individuals. The Civil Law tradition has its roots in the French Revolution and in the sovereignty of the national legislative assembly as the only legitimate lawmaker of the State. The unity of the law does not depend on decisions of courts but only on the legislature. Constitutions of Civil Law federations need to enable the specified governmental branches of the federation to impose sanctions against federal units that fail to comply with federal laws. According to the perspective of the Civil Law one has to deal with two ‘States’ claiming sovereignty in a hierarchy, while from the perspective of the Common Law one has to deal with mere ‘governments.’ Constitutions of multicultural federations embedded within the Civil Law culture will have to empower not just the federation but also the federal units to develop the different cultural identities. To foster different cultures is however, not a major function of the State of the Common Law tradition. Federalism of the Civil Law tradition is more complex than according to the Common Law tradition. Important differences between federations of a Common Law and Civil Law tradition lies in the lawmaking power of the courts. In Common Law, courts and legislature share the task of lawmaking; in Civil Law countries, the legislature regulates all issues of civil and criminal law. In a Civil Law country, legislatures, executives and courts cannot function if there is no valid local Constitution empowering those branches of the federal units. Thus, the federal Constitution of a civil law country has to establish the powers of the governmental branches of the federal units. Within federal system of the Civil Law, the federal units administer, implement and execute the laws of the federation. Constitutions of Civil Law federations need special provisions for the power of the federation to control and implement federal laws in the federal units. The civil law judiciary has no contempt of court against the administration and against authorities of federal units.

Undoubtedly, capital markets have an impact on investment appraisal decisions through interest rates (cost of capital) charged and debt covenants stipulated in debt contracts. However, the extent of influence of their interactions in shaping and determining a firm’s corporate governance policy, agency costs, investment decisions and firm value has been overlooked or not duly emphasised in the literature to date. This lack of interdisciplinary research in areas such as finance, accounting, capital markets and corporate governance may lead financial managers making wrong interpretation of the current empirical evidence. This may result into suboptimal decisions in capital budgeting decisions. There are various existing studies that have discussed the relation between corporate governance and one or two other business topics this paper is assessing. However, questions have persisted about the role capital markets’ interactions play in determining firm’s corporate governance, minimizing agency costs, long term investment decisions and firm value. The recent high profile global company collapses mainly due to poor corporate governance mechanisms have rekindled the interest in the role capital market interactions play in formulating firm’s corporate governance rules and policies and their impact on agency costs, investment appraisal decisions and firm value. This study intends to assess this issue and critically evaluates these related issues. The impact of multiple objectives on long-term investment decisions is also discussed. We find that capital market interactions have a significant impact in the way firms formulate their corporate governance, identify and control agency costs, optimize multiple objectives, make investment decisions and determine firm value. In a nutshell, there is a consensus among researchers that capital markets impact on capital investment decisions and firm value through interest rates, debt covenants that impact on managers’ self-interest behaviour, corporate governance policies and agency costs.

Mediating Effects of Accounting Conservatism on The Relationship Between Corporate Governance and Cost of Capital

Federal insider-trading law consists, for the most part, of federal common law rooted in a statutory regime that prohibits fraud in connection with the purchase or sale of securities. Commentators have long lamented this fact, viewing the law’s grounding in an anti-fraud statute as a quirk of history with little to recommend it. After all, what does fraud have to do with insider trading? A lot, it turns out. In this article, I develop a theory explaining and defending the fraud-based nature of federal insider trading law. Specifically, I argue that Rule 10b-5, the anti-fraud rule in question, should be understood as altering the common law rule barring parties from contracting for fraud liability. As contract scholars have shown, this common law rule prevents contracting parties from effectively deterring certain hard-to-detect breaches of which insider trading is but one example. Rule 10b-5, I argue, reverses the common law rule, allowing contracting parties to contract for fraud liability and the accompanying extra-compensatory damages for insider trading. The implications of this new theory of insider trading law are significant. First, this theory helps us explain the law as it’s been received, something that competing theories simply can’t do. Second, it implies that insider trading liability under Rule 10b-5 should not be limited to fiduciaries but should include trading by at least some non-fiduciaries as well. Third, this theory provides courts with a tractable way of determining the scope of Rule 10b-5 – they must ask whether the trader and the information source are likely to have contracted for insider trading liability under Rule 10b-5, an inquiry that turns in part on the availability of alternatives to fraud liability for deterring insider trading. Fourth, and finally, the contractual fraud theory of insider trading law implies that, interpreting these implicit contracts over information, the SEC can cast a broader liability net than courts. Consequently, this theory explains not just the Supreme Court’s insider trading jurisprudence but also rules promulgated by the SEC, like rule 10b5-2, which are thought to go beyond the limits of the Court’s interpretation of the statute. This theory implies that the SEC is well within its authority to adopt Rule 10b5-2, a proposition that has been called into question by some federal courts.

This study examines the relationship between corporate governance (CG) and agency costs using Korean market data, particularly for chaebol firms. The final sample includes 660 firm-year observations between 2016 and 2020 for Korean non-financial firms listed on the Korean Composite Stock Price Index (KOSPI). This study employs an ordinary least-squares panel data regression model using two proxies for agency costs, namely, asset utilization ratio and operating expense ratio, and six CG individual metrics as independent variables (CG score, protection of shareholder rights, board structure, disclosure, audit organization, and managerial discretion and error management). We find that firms with high CG experience lower agency costs than those with low CG. Moreover, our evidence suggests that firms can decrease agency costs by improving the quality of CG. The results of our regression model also support the idea that CG is effective in reducing agency costs for chaebol firms but not for non-chaebol firms. Finally, our findings suggest that the implementation of effective CG mechanisms in firms might improve managerial behavior through better decision-making to maximize the value of firms.

Chinese Characteristics Compared: A Legal and Policy Perspective of Corporate Finance and Governance in Taiwan and China

ABSTRACTManuscript Type: EmpiricalResearch Question/Issue: We examine whether corporate governance plays a role in influencing a firm's choice of financing, i.e., equity versus debt. We hypothesize that the likelihood of equity financing increases with governance because of a reduction in agency costs between investors and managers in these firms. While the reduction in agency costs occurs for both equity and debt financing, we argue that there is a more significant effect on equity financing.Research Findings/Insights: Using a sample of over 2,000 US equity and debt issuances over the period 1998 to 2006, we find that our measures of corporate governance effectiveness have a positive impact on the likelihood of choosing equity compared to debt. This association is more pronounced in small firms where information asymmetry is higher between managers and investors.Theoretical/Academic Implications: Our findings refine and extend the pecking order hypothesis, which suggests that firms will issue equity as their last resort because of the high information asymmetry associated with equity financing. We provide some of the first evidence that the pecking order hypothesis can be mitigated by corporate governance. Specifically, we find that the likelihood of issuing equity increases as governance increases. Further, we find that where agency costs due to information asymmetry are greater, the positive impact of governance on the likelihood of equity financing is also greater. That is, in support of agency cost theory, we find that firms facing high agency costs benefit the most from investing in corporate governance mechanisms that lower the agency costs. We are not aware of any prior study, published or unpublished, that has documented this result.Practitioner/Policy Implications: From a practical perspective, our study suggests that firms wishing to access equity capital markets should pay attention to their corporate governance. Specifically, by investing in corporate governance systems, firms facing high agency costs may be able to obtain easier access to not just debt but also equity markets. From a practice standpoint, in the years prior to securing financing, firms should consider making improvements to their governance (e.g., changes to board structure and/or auditor), carefully weighing the costs of making these improvements against the benefits of securing better and cheaper access to equity markets.

The separation of ownership from control produces a condition where the interests of owner and of ultimate manager may, and often do, diverge, and where many of the checks which formerly operated to limit the use of power disappear.... In creating these new relationships, the quasi-public corporation may fairly be said to work a revolution. It ... has divided ownership into nominal ownership and the power formerly joined to it. Thereby the corporation has changed the nature of profit-seeking enterprise.1