International Law

More Transparency Talk

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Megan McArdle is another commentator who believes in the myth of disclosure in the earnings opportunities markets.

"I would much rather see America's regulators do what government is really good at:  transparency and coordination. 

Providing as much detailed information about firms, securities, and markets as they can, particularly in assessing systemic risks. 

Serving as a locus, with muscle if necessary, to help multifold private actors create institutions that reduce risk. 

Delineating and carrying through the procedures for dealing with the inevitable failures."

There is very little evidence that more disclosure makes markets less risky.

The reason for this is deceptively simple, and can be seen more clearly in the markets for franchises, business opportunities and other income generating distributorships.

In a franchise, if the franchisee does poorly, the franchisor who makes money off the gross and not net profits, still can do well.  There is no linkage between the two.

In the equities market, if the CEO takes on a great deal of risk for the company, for which he or she is not personally responsible for, and stands to gain enormously if the gamble pays off, there is misplaced incentives.

In franchising, there is a myth that franchises are less risky that ordinary start-ups.  This myth attracts investors who should be looking at independent operations.

In the equities and bond market, we have the myth of covariance.  The idea that a model portfolio can minimize risk thought of as variance from a normal return.

In franchising and business opportunities, we have regulators who tells us that they haven't checked the disclosure documents so we should.  Knowing full well that 95% cannot even read the disclosure document.

In the equities market, we have a regulator who cannot possibly even audit 15% of the submitted financial statements.  More transparency would mean even less audits.

It is simply not realistic to think that these major calamities in the passive income earnings markets can be fixed by emphasis on a single criteria - in Megan's case transparency, and in Mark Cuban's case misplaced incentives.

What is needed is a complete Munger Lollapazaloo analysis, complete with picking eight or nine psychological effects that were all pointing in the same direction.

My readers are invited to make submissions.

Full post as published by Misleading Advertising Law on September 16, 2008 (boomark / email).