Markets versus Mechanisms

Boleslavsky, R, Hennessy, C and Kelly, D L (2022) Markets versus Mechanisms. Review of Financial Studies, 35 (7). pp. 3139-3174. ISSN 0893-9454

Abstract

We establish limitations to the usage of direct revelation mechanisms (DRMs) by corporations seeking decision-relevant information in economies with securities markets. In this environment, posting a DRM increases the informed agent’s outside option: if the agent rejects the DRM, he convinces the market he is uninformed, and he can aggressively trade with low price impact, thereby generating large (off-equilibrium) trading gains. This endogenous outside option may make using a DRM to screen uninformed agents impossible. When screening is possible, solely relying on the market for information is optimal if the increase in outside option is sufficiently large.