Financial Economics

20

CAPITAL MARKET IMPERFECTIONS AND FINANCIAL DECISION CRITERIA

In this chapter we recognize a variety of capital market imperfections and then outline their consequences for the financial theories we have so far developed. Capital market imperfections have a potential for creating important consequences for financial decision making. However, these consequences depend both on the nature and on the ubiquitousness of the imperfections. These are matters related more closely to applications than to theory and we will explore applications further in the book's remaining parts. But first it is useful to outline how the theory itself is changed by the phenomena we now recognize.

We shall argue that the major imperfection affecting financial market prices involves the collection and dissemination of information that seems often to be distributed quite unevenly. At the same time, auction markets like the stock exchanges are clearly efficient despite the presence of such imperfections as transactions costs. Thus, in the sequel we shall pay considerable attention to heterogeneously distributed information and less to issues involving explicit charges such as flotation and brokerage costs. We also argue, on occasion, that markets may be incomplete in the sense of Chapter 16, and the effects of incompleteness will, from time to time, augment the effects of heterogeneously distributed information.

20.1 TYPES OF CAPITAL MARKET IMPERFECTIONS

There are several kinds of capital market imperfections ...