Information, Non-Excludability, and Financial Market Structure
Yale SOM Working Paper #2
43 Pages Posted: 28 Oct 1997
Date Written: July 1997
We study the determinants of market structure in financial intermediation markets when property rights over information are weak. We show that incentives to gather information to screen firms can be preserved in decentralized markets with more than one intermediary. In equilibrium, each intermediary possesses local monopoly power, which is preserved by implicit contracts between intermediaries. These, in turn, impose constraints on aggregate market structure. We examine the robustness of such self-enforcing behavior to entry and present a theory in which market structure is endogenously determined.
We obtain the following results: 1) There cannot exist a single dominant intermediary in equilibrium; rather, they must be few and of similar sizes. 2) Even with no entry costs, intermediaries may still make profits in equilibrium. 3) Increases in market size may have no effect on concentration. 4) Changes in entry costs do not affect prices and may not affect concentration.
We apply our theory to two markets -- investment banking and venture capital -- and use it to organize and interpret the evidence.
JEL Classification: G20, L22
Suggested Citation: Suggested Citation