The following post comes to us from Alessio Pacces
, Professor of Law and Finance at the Erasmus School of Law in Rotterdam. The post is based on Professor Pacces’ inaugural lecture for the Chair in Law and Finance at the Erasmus School of Law in Rotterdam. The full text of the lecture is available here
Traditionally, law and finance has been concerned with investor protection. That would be enough if the future were predictable. However, because the future is in fact uncertain and unpredictable, the prices of financial assets are flawed and in the short run they may result in serious mistakes, if not widespread crises. Although these mistakes are corrected in the long run, a lot of harm may occur in the meantime. Drawing on the experience from the global financial crisis, I argue that financial law should be concerned not only with investor protection, but also with mitigating the temporary excesses of markets in allowing or restricting access to finance.
The challenge of this goal is to remedy market malfunctioning without undermining market discipline. This is possible if central banks backstop banks’ illiquidity during a crisis, provided that regulation preserves the central banks’ incentives to distinguish illiquidity from insolvency. Moreover, in order to prevent the backstop from resulting in moral hazard by financial institutions, regulation should police the incentives of both managers and shareholders. On the one hand, bank managers should not be allowed to cash in the profit of short-term success. On the other hand, corporate law should allow shareholders to commit to the long term via takeover restrictions, granting bankers private benefits of control to complement the deferral of performance pay.
…continue reading: The Future in Law and Finance