Prediction Markets for Corporate Governance

55 Pages Posted: 8 Sep 2006 Last revised: 8 Oct 2007

Michael Abramowicz

George Washington University Law School

M. Todd Henderson

University of Chicago - Law School

Abstract

Building on the success of prediction markets at forecasting political elections and other matters of public interest, firms have made increasing use of prediction markets to help make business decisions. This Article explores the implications of prediction markets for corporate governance. Prediction markets can increase the flow of information, encourage truth telling by internal and external firm monitors, and create incentives for agents to act in the interest of their principals. The markets can thus serve as potentially efficient alternatives to other approaches to providing information, such as the Sarbanes-Oxley Act's internal controls provisions. Prediction markets can also produce an avenue for insiders to profit on and thus reveal inside information while maintaining a level playing field in the market for a firm's securities. This creates a harmless way around existing insider trading laws, undercutting the argument for the repeal of these laws. In addition, prediction markets can reduce agency costs by providing direct assessments of corporate policies, thus serving as an alternative or complement to shareholder voting as a means of disciplining corporate boards and managers. Prediction markets may thus be particularly useful for issues where agency costs are greatest, such as executive compensation. Deployment of these markets, whether voluntarily or perhaps someday as a result of legal mandates, could improve alignment between shareholders and managers on these issues better than other proposed reforms. These markets might also displace the business judgment rule because they can furnish contemporaneous and relatively objective benchmarks for courts to evaluate business decisions.

Suggested Citation

Abramowicz, Michael and Henderson, M. Todd, Prediction Markets for Corporate Governance. Notre Dame Law Review, Vol. 82, No. 4, 2007; U Chicago Law & Economics, Olin Working Paper No. 307; GWU Law School Public Law Research Paper No. 221; GWU Legal Studies Research Paper No. 221. Available at SSRN: https://ssrn.com/abstract=928896

Michael B. Abramowicz

George Washington University Law School ( email )

2000 H Street, N.W.
Washington, DC 20052
United States

M. Todd Henderson (Contact Author)

University of Chicago - Law School ( email )

1111 E. 60th St.
Chicago, IL 60637
United States
773-834-4168 (Phone)
773-702-0730 (Fax)

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