This paper demonstrates that market makers have the ability and incentive to facilitate price discovery in securities markets. Market makers can expedite the process of intertemporal price formation by setting prices to induce statistically more informative order flow. Such actions constitute an investment in the production of information. Under certain conditions, market makers can recoup the cost of this investment by making better pricing decisions in the future with more precise information. These conditions are analyzed in a general model and several examples that illustrate the complex nature of price discovery are presented.
Moral hazard is reduced as a result.
In this paper we analyze how depositors can employ both monitoring and capital requirements to control the risk of bank assets. We also analyze how monitors should be compensated if their actions are not directly observable and if there are binding limits on their liability. We derive some results about the nature of these distortions and characterize the optimal incentive scheme for monitors. We find that fixed-price tenders pay higher premiums to retire greater equity fractions than Dutch offers yet generate similar total returns to stockholders. Accordingly, total returns are significantly higher in Dutch auctions after controlling for tender and firm characteristics.