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28 J. Corp. L. 541 (2002-2003)
Market Microstructure and Market Efficiency

handle is hein.journals/jcorl28 and id is 551 raw text is: Market Microstructure and Market Efficiency Paul G. Mahoney* I. IN TRO D U CTIO N ........................................................................................................ 54 1 II. M ARKET STRUCTURE I: INTERMEDIARIES ............................................................... 543 III. MARKET STRUCTURE II: INFORMATIONAL ASYMMETRY ........................................ 546 IV . C O N C LU SIO N ........................................................................................................... 549 I. INTRODUCTION One of the most important developments in economic theory over the past twenty years is a focus on institutions as constraints on economic agents. Laws, social norms, and other rules that channel behavior into particular directions have become central objects of study. Prior work in economics tended either to abstract away from institutions or to take them for granted. A justification for these approaches was the view that institutions arise when they are efficient in the sense of economizing on transactions costs. 1 In that framework, institutions are an output of the economic system, like prices or production. A more recent tradition treats institutions as inputs that help explain some of the cross-sectional variation in prices, economic growth, financial development, or other output variables.2 This is not to say that institutions are exogenously imposed, but simply to note that institutions (however they may arise) may survive even if they are inefficient.3 Earlier analyses posited that institutions, like individuals, are subject to the competition of the market and only those that are efficient will survive over the long run.4 This ignores, however, the fact that an existing regime may generate rents or settled expectations for some subset of agents, and those agents may resist change. Although the institutional approach is often associated with economic history, it has more recently taken deep root within financial economics. Economists have devoted considerable attention to the role that corporate law, for example, plays in the operation * Brokaw Professor of Corporate Law and Albert C. BeVier Research Professor, University of Virginia School of Law. I am grateful to conference participants for comments and to Kelly King for research assistance. 1. See RONALD COASE, The Theory of the Firm, 4 ECONOMICA 38b (1937). 2. Douglass North is one of the main proponents of this view. See, e.g., DOUGLASS C. NORTH, INSTITUTIONS, INSTITUTIONAL CHANGE, AND ECONOMIC PERFORMANCE (1990). 3. For one example of a model in which social norms survive an evolutionary process despite their inefficiency, see Paul G. Mahoney & Chris Sanchirico, Competing Norms and Social Evolution: Is the Fittest Norm Efficient?, 149 U. PA. L. REV. 2027 (2001). 4. See Arman A. Alchian, Uncertainty, Evolution, and Economic Theory, 58 J. POL. ECON. 211 (1950).

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