Brookings-Wharton Papers on Financial Services 2002 (2002) 345-360
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Information Technology and the Organization of Securities Markets
Paul G. Mahoney
WHAT THE FUTURE holds for securities markets is, of course, a remarkably broad subject. In an effort to maintain focus, I pose two questions related to the issue of technology and its implications for the future of securities markets. First, will technology tend to increase or decrease the importance of securities as a financing vehicle in comparison to alternative vehicles such as bank loans, capital leases, and franchising relationships? Second, what changes will technology produce in the structure of primary and secondary securities markets? I take up these questions in order.
Securities Versus Other Financing Methods
The question of the relative importance of securities as a financing vehicle is, I believe, the easier of the two to answer. By increasing the size and decreasing the costs of trading in secondary securities markets, technology will play to the strengths of securities and lead even more financial transactions to take place through securities markets.
The comparative strengths of securities as a means of financing a project are obvious. All of the essential features of securities are designed to facilitate their trading on a secondary market. Their terms are standardized so that a single piece of paper can alert a purchaser to the principal ways [End Page 345] in which one differs from another. The bulk of the detailed rights and obligations that attach to a share of stock are found in the corporate code of the state of incorporation of the issuer and in the issuer's charter. Both are publicly available and usually contain familiar provisions. Statutory and judge-made corporate law provides a few default settings that a charter may alter, but the range of choices is well known. Although the details vary, the same basic arrangement holds for debt securities. Debt securities are issued in the U.S. markets under an indenture, a contract between the issuer and a trustee for the benefit of investors. The indenture, although lengthy, is highly standardized, and deviations from the typical default settings can ordinarily be identified on the certificate itself.
Other features of securities also make their transfer a simple matter. They are one-sided obligations—the initial purchaser complies with all its material obligations by paying the purchase price, and, accordingly, the identity of the holder is a matter of indifference to the issuer. (The exception is in circumstances such as takeovers and restructurings, but there the issuer's concern is not that the holder has obligations, but that it may have amassed formidable rights to control the issuer's decisions.) They can be broken into retail-size pieces, and a transfer agent is provided to record transfers, provide certificates registered to the new owner, and, if necessary, exchange, say, one certificate representing 500 shares for five certificates representing 100 shares each.
In short, these simple features—so simple it is easy to overlook them—make securities, in contrast to other contracts, transferable at a trivial marginal cost to the holder. Most of the cost of transfer is sunk—it consists of the resources devoted to the development of corporate law, standard-form indentures, Articles 3 and 8 of the Uniform Commercial Code, and the creation of transfer agencies and the contracts they enter into with issuers. Among the myriad forms of contracts, only bank checks have had a similarly extensive infrastructure created to facilitate transfers.
Technology is rapidly decreasing the marginal costs of transfer. Trading systems now permit securities sellers and buyers to transact for fees that would have been impossibly low a generation ago. In that sense, technology has reinforced the principal advantage of securities compared to other financing vehicles.
One might still ask, however, whether technology is having a disparate impact on securities markets compared to, say, banking markets. Surely technology makes it as easy for bankers to gather, analyze, and disseminate [End Page 346] the information necessary to their business as for brokers and investment bankers to do so. If...