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During the past several years, the business community has been fascinated by a debate over the functioning of capital markets and the need for market reform. Contributing to the debate are a variety of academics, investors, financial commentators, and government policymakers who, through published reports and research, are challenging the conventional wisdom of market efficiency and laissez-faire economics. Some have focused on the functioning of the capital markets and its effectiveness in resource allocation.1 Others have investigated the related topics of financial reporting regulation and corporate governance.2 Still others are challenging the financial accounting tradition by arguing for new accounting models that use more nonfinancial performance measures to capture the returns to strategic investments in technology infrastructure and core competence.3 The intent of all these reports has been to offer insight into the complex interrelationships among patterns of information flow, capital market efficiency, and the competitive performance of U.S. industrial enterprise.4
It is perhaps not surprising that the studies, reports, and articles have generally created more confusion than clarity. Rather than contributing to a single, shared perspective of market functioning, the studies offer a multitude of theories and definitions of market activity that have served only to aggravate the debate, drawing more distinct political and rhetorical boundaries between supporters and critics.
On one side of the rhetorical divide are the economists who argue that unfettered markets offer the most economically rational means for capital allocation. They support the basic economic notion that the markets are efficient and, if left to function freely, will allocate capital to maximize risk-adjusted returns. They also tend to believe that a company’s stock price is an effective summary statistic of its performance. In general, they see no need to reform market functioning or modify substantively the information flow driving market activity. To buttress their view, these economists point to the liquidity, flexibility, and size of the U.S. markets as evidence of their effective functioning.5 They also rightly note that U.S. reporting standards are some of the most developed and sophisticated in the world.
On the other side of the debate are the critics. Generally, they argue that the institutional and regulatory structures supporting market activity are flawed and have failed to provide adequate safeguards against wasteful management and inappropriate corporate investment. They also decry the “short termism” of the markets.
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1. See, for example:
R. Kuttner, The End of Laissez-Faire: National Purpose and the Global Economy after the Cold War (New York: Random House, 1991);
J. Grant, Money of the Mind: Borrowing and Lending from the Civil War to Michael Milken (New York: Farrar Straus Giroux, 1992);
S. Klarman, Margin of Safety: Risk Averse Value Investing Strategies for the Thoughtful Investor (New York: HarperBusiness, 1991); and
L. Thurow, Head to Head: The Coming Financial Battle between Europe, Japan, and America (New York: Morrow, 1992).
2. See J. Coffee, L. Lowenstein, and S. Rose-Ackerman, eds., Knights, Raiders & Targets: The Impact of Hostile Takeovers (New York: Oxford University Press, 1988); and
L. Lowenstein, What”s Wrong with Wall Street (Reading, Massachusetts: Addison-Wesley, 1988), and Sense and Nonsense in Corporate Finance (Reading, Massachusetts: Addison-Wesley, 1991).
3. See J.V. McGee and R.G. Eccles, “Business Models and Performance: Improving Dialog about Measurement”