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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