| Summary: | The theses focus on the market failure induced by information imperfection. We study this type of market failure separately in the context of corporate equity finance and long-term bilateral transactions. In the equity finance market, adverse selection may arise due to the asymmetric information of firms’ value. It has been argued that firms, in response to the inefficiency induced by adverse selection, may signal their unobservable values through choices of equity flotation methods. In the context of UK open offers and rights offers, we provide evidences for this signalling hypothesis. We find that information content significantly falls after both rights offers and open offers, which suggests resolution of asymmetric information with equity offers. Our result suggests there exists a non-pooling equilibrium through firms’ choices of equity flotation methods and that open offers are employed by good firms to signal quality to the public. Besides, with the measures of information content of trades, we establish some patterns of adverse selection in London SEAQ. Information content of trades is related to trade size. Small trades are not informative, while median trades and large trades are informative. For the comparison between purchases and sales, large purchases are more informative than large sales, while median purchases are less informative than median sales. These results suggest informed traders handle large purchases and large sales with different strategies, and that market makers are less harsh to traders with positive private information. We set up a hypothesis of the pattern of human intermediation in London SEAQ: human intermediation works in a “carrot” format when private information is more costly to obtain and adverse selection is more severe; it works in a “stick” format when information of a stock can be generated for less less cost and market makers face fewer threats from informed trading. In most long-term bilateral trading relationships, transaction parties have to make investments which are geared towards their partners. Once the investments are sunk, a party can not rely on market to discipline his partner, and his investments return will be vulnerable to expropriation. This problem, known as the hold-up problem, will discourage parties from making socially desirable investments. We reconsider the hold-up problem by allowing a party to separately invest in his outside option in order to capture its value. We find that after considering this investment option, the hold-up problem is potentially more severe than previously observed. Parties to a transaction may make investments which are not productive from a social point of view. More importantly, the inefficient investment may even crowd out relationship specific investments, which may result in relationship-breaking in a highly productive relationship.
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