Markets vs. Mechanisms

49 Pages Posted: 29 Sep 2017 Last revised: 30 Sep 2017

See all articles by Raphael Boleslavsky

Raphael Boleslavsky

University of Miami - School of Business Administration - Department of Economics

Christopher Hennessy

London Business School

David L. Kelly

University of Miami - School of Business Administration - Department of Economics

Date Written: September 27, 2017

Abstract

We demonstrate constraints on usage of direct revelation mechanisms (DRMs) by corporations inhabiting economies with securities markets. We consider a corporation seeking to acquire decision relevant information. Posting a standard DRM in an environment with a securities market endogenously increases the outside option of the informed agent. If the informed agent rejects said DRM, then she convinces the market that she is uninformed, and she can trade aggressively sans price impact, generating large (off-equilibrium) trading gains. Due to this endogenous outside option effect, using a DRM to screen out uninformed agents may be impossible. Even when screening is possible, refraining from posting a mechanism and instead relying on markets for information is optimal if the endogenous change in outside option value is sufficiently large. Finally, even if posting a DRM dominates relying on markets, outcomes are improved by introducing a search friction, which randomly limits the agent's ability to observe the DRM, forcing the firm to sometimes rely on markets for information.

Keywords: Market Microstructure, Mechanism Design

JEL Classification: G32, L14, D83

Suggested Citation

Boleslavsky, Raphael and Hennessy, Christopher and Kelly, David L., Markets vs. Mechanisms (September 27, 2017). Available at SSRN: https://ssrn.com/abstract=3043848 or http://dx.doi.org/10.2139/ssrn.3043848

Raphael Boleslavsky (Contact Author)

University of Miami - School of Business Administration - Department of Economics ( email )

P.O. Box 248126
Coral Gables, FL 33124-6550
United States

Christopher Hennessy

London Business School

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

David L. Kelly

University of Miami - School of Business Administration - Department of Economics ( email )

P.O. Box 248126
Coral Gables, FL 33124-6550
United States

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