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Governing Capital Markets

This chapter applies competence–control theory to capital market governance. For much of the twentieth century, centralized market intermediaries such as the New York Stock Exchange and London Metal Exchange served as efficient platforms for capital formation and risk management. However, this pattern of good self-regulatory governance was displaced by socially unproductive rent-seeking and widespread distortions following the introduction of increased competition between fragmented exchange platforms and external statutory controls. The governor’s dilemma provides an elegant framework for explaining this deterioration in the quality of capital market governance, which confounds standard expectations about the salutary effects of competition and the presumed vices of self-regulation. Unpacking the changing modalities of governor control (cooptation versus delegation) and the impact of differences in market structure (centralization versus fragmentation), this chapter shows that good market governance was supported by soft control mechanisms and a radical attenuation of the competence–control tradeoff in centralized markets. This efficient equilibrium unraveled as growing goal divergence—induced by market fragmentation—encouraged harder governor controls that inadvertently eroded the competence of market intermediaries.