This commentary appeared in Wall Street Journal on September 27, 2002.
Contrary to the familiar adage, every cloud does not have a silver lining.
Thankfully, however, some do. The clouds cast by the recent freshet of corporate
fraud and other derelictions have a brighter side that will improve the efficiency
of equity markets in the future.
Among the acknowledged sources of brightened prospects are the recently enacted
Sarbanes-Oxley law requiring chief executives and chief financial officers to
certify the accuracy and completeness of corporate accounts, and invoking serious
criminal penalties including jail time for violations; improvements that have
been made in the Securities and Exchange Commission's capabilities for rigorous
yet sensible regulatory scrutiny of public companies; and the wake-up shock
administered to corporate officers and independent directors to take their fiduciary
responsibilities more seriously in the future than they may have in the past.
These developments, while important, are confined to the sell side of the
market. More important, and less recognized as a stimulus to more efficient
equity markets, is the buy side. Efficient markets require participants -- buyers
no less than sellers -- to have equivalent access to information and the capacity
to use it. By strengthening incentives for investors to become more informed
and knowledgeable, recent corporate malfeasances should help to promote more
efficient equity markets, improved resource allocations, and a more productive
A recent comment by AFL-CIO President John Sweeney -- not always a fan of
efficient markets -- is a cogent reminder of the direction of needed change:
"The sad truth," observed Mr. Sweeney, "is that American consumers
can shop with more assurance of quality and safety at their corner grocery store
than American investors can shop for equities in our stock market."
To be sure, bets with a longer-term horizon are inherently more risky than
ones with a shorter term. But the principal reason consumers can shop with more
assurance in markets for groceries as well as for appliances, vehicles, housing,
and other durable consumer goods is that consumers are more knowledgeable about
these products than they are about the products offered in equity markets.
Financial professionals scoff at this line of argument, contending in rebuttal
that investment products are too technical and arcane for individual investors
to understand as well as they understand consumer products and services. This
rebuttal has limited merit, as well as more than a limited dose of self-interest
associated with it.
Individual investors don't have to become financial professionals any more
than consumers of health care have to become physicians. But it is entirely
possible for investors to become sufficiently knowledgeable about investment
products to ask the right questions and demand the information necessary to
make better decisions in accord with their own preferences and judgments. Indeed,
in the wake of recent corporate defalcations, investors now have stronger incentives
to become better informed about the following types of technical issues that
will affect investor behavior and, in the process, contribute to more efficient
The efficiency of equity markets definitely will be enhanced by rigorous enforcement
of old and new regulatory legislation. But in the final analysis more efficient
equity markets depend fundamentally on better-informed and more discerning individual
and institutional investors. While the sell side of the market needs to be monitored,
the buy side requires serious upgrading as well.
Explore All Topics »