Security Price Informativeness with Delegated Traders

Abstract

We study the "efficient markets" paradigm in the context of agency relations: principal-investors want to monitor and compensate their agent-traders using market security prices in "mark-to-market" contracts. The view of each principal is that market prices aggregate the information from other market participants so they can be used to monitor agent-traders. If the market is dominated by such delegated traders, then these traders can attempt to manipulate the market price by shirking jointly and buying or selling in the same direction. In this way, traders provide market "proof" that they have worked hard and deserve high compensation. We show that markets dominated by delegated traders are less efficient than other markets. The extent of "market efficiency," indexed by the delegated traders' propensity of joint shirking, is endogenized.

Keywords: agency problem, mark to market, market efficiency

JEL Classification: G12, G14, G20