Information Asymmetry and Information Failure: Disclosure Problems in Complex Financial Markets

Authors

• Steven L. Schwarcz, Duke Law SchoolFollow

Document Type

Chapter of Book

Publication Date

2011

Abstract

Disclosure of information has been a key to regulation of the financial markets in the United States. Indeed, some have argued that the ‘exclusive focus [of federal securities regulation] is on full disclosure’ (Hazen, 2005). Yet there is relatively little dispute that although most if not all of the risks giving rise to the collapse of the market for structured securities backed by subprime mortgages were disclosed, the disclosure was ineffective. Disclosure failed because of the complexity of those securities and transactions.

This chapter examines disclosure’s insufficiency in addressing information asymmetry, arguing that complexity can cause information failure. There are multiple layers to complexity, the most obvious being complexity caused by increasingly complicated financial securities. But price volatility and liquidity of securities can be nonlinear functions of the interactive behaviour of independent and constantly adapting market participants, producing not only cognizant complexity (i.e., too complex to understand) but also a temporal complexity within securities markets in which events tend to move rapidly into a crisis mode with little time or opportunity to intervene. Complexity also can cause information failure by exacerbating the misalignment of interests both between firms and their managers, especially technically proficient secondary managers, and also between individual firms and third parties. The chapter concludes that complexity makes reliance on disclosure insufficient, and that solutions will be only second best.

Comments

© Cambridge University Press 2011. This version is free to view and download for private research and study only. Not for re-distribution or re-use.

Citation

Steven L. Schwarcz, Information Asymmetry and Information Failure: Disclosure Problems in Complex Financial Markets, in Corporate Governance and the Global Financial Crisis: International Perspectives 95-112 (William Sun, Jim Stewart & David Pollard eds., 2011)