Functions of information Marketplaces and Securities Firms

Because it is impossible to establish a covenant relationship for price-related information, one has to organize a private information marketplace built upon an informal network of connections. To build and maintain a functional private information marketplace, securities firms offer information providers incentives in the form of compensation for the information provided. They also make threats of expulsion against providers who fail to comply with market rules and give false information. (Of course, a credible threat works on the premise that the increase in gains from short-term fraud is far lower than the benefits of long-term involvement.)

To attract investors, securities firms are responsible for ensuring the high quality of, and accurate pricing for, the subjects for investment. If a securities firm fails its due diligence or is incapable of bringing about effective pricing of assets, it would lose the investor's trust and would be consequently abandoned, suffering a profit loss in the long run. Therefore, securities firms are motivated to treat every business in a prudent manner and to make every effort to maintain their reputation. Figure 2.1 depicts the relationships between the parties in a private information marketplace.

Securities Firm

FIGURE 2.1 Securities Firm's Information Marketplace

Source: Morrison and Wilhelm (2007).

Information producers create and supply useful information to securities firms in exchange for compensation. Large investors provide sufficient liquidity that helps the successful issuance of securities. As buyers of information, issuers normally learn about market reaction and demand for the securities issued via securities firms. Retail investors, whose aggregate demand accounts for a certain portion in every market, constitute an investor group that cannot be ignored because they take advantage of large investors. Securities firms also participate in some investment activities in the secondary market for the following reasons[1]:

- It could provide an exit path for the parties in the primary market, thereby helping reduce the cost of the liquidity network.

- It could learn directly about market reaction, helping promote issuance in the primary market.

- It could make additional gains for the information network.

Securities firms may also channel the secondary market of derivatives and services into the IPO process.

  • [1] See Morrison and Wilhelm (2007).
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