The paper presents an empirical analysis of the alleged transformation of the financial systems in the three major European economies, France, Germany, and the United Kingdom. Based on a unified data set developed on the basis of national accounts statistics, and employing a new and consistent method of measurement, the following question is addressed: Is there a general trend toward disintermediation, with banks losing importance to the markets, that is causing these three financial systems to converge? We find that there is neither a general trend toward disintermediation, nor toward a transformation from bank-based to capital market-based financial systems, nor toward a loss of importance of banks. Only in the case of France could strong signs of transformation as well as signs of a general decline in the role of banks be found. Thus the three financial systems also do not seem to be converging. However, there is also a common pattern of change: the intermediation chains are lengthening in all three countries. Nonbank financial intermediaries are taking over a more important role as mobilizers of capital from the nonfinancial sectors. In combination with the trend toward securitization of bank liabilities, this change increases the funding costs of banks and may put banks under pressure. In the case of France, this change is so pronounced that it might even threaten the stability of the financial system. Journal of Economic Literature Classification Numbers: G21 and G23

This paper examines how the legal environment affects financial development, and then asks how this in turn is linked to long-run economic growth. Financial intermediaries are better developed in countries with legal and regulatory systems that (1) give a high priority to creditors receiving the full present value of their claims on corporations, (2) enforce contracts effectively, and (3) promote comprehensive and accurate financial reporting by corporations. The data also indicate that the exogenous component of financial intermediary development—the component defined by the legal and regulatory environment—is positively associated with economic growth. Journal of Economic Literature Classification Numbers: G21, K12, O16

We analyze price competition between dealers in a security market where the bidding process is sequential. The model provides an interpretation for the evolution of the best ask and bid prices, in between transactions. We find that convergence to the competitive ask and bid prices can take time. The speed of convergence is determined by the frequency with which dealers check their offers and by the tick size. This creates a relationship between the expected trading cost and the timing of offers posted by the dealers. We also find that a zero minimum price variation never minimizes the expected trading cost. Finally, we study the role of time priority. Journal of Economic Literature Classification Numbers: D43, G10.

We develop a model of corporate myopia in which the interaction between asymmetric information and short-term trading by equity holders induces firms to undertake short-term rather than long-term projects, which are intrinsically more valuable. We study the effectiveness of alternative policy prescriptions in eliminating myopia. We show that a capital gains tax cut for long-term equity holders induces optimal project selection; an across-the-board tax cut has no such impact. We characterize the long-term capital gains tax rate which eliminates corporate myopia. Further, we show that a long-term capital gains tax cut does not induce a bias toward inefficient long-term projects when it is, in fact, short-term projects which are more valuable. In contrast, an investment tax credit directed at long-term projects leads to such a bias. Finally, we show that reducing the long-term capital gains tax rate to the level required to eliminate myopic investment behavior may also lead to an increase in government tax revenues.Journal of Economic Literature Classification Numbers: H21, G31, D82.

The standard Principal–Agent (PA) model assumes that the principal can control the agent's consumption profile. In an intertemporal setting, however, Rogerson (1985, Econometrica53, 69–76) shows that given the optimal PA contract, the agent has an unmet precautionary demand for savings. Thus the standard PA model is invalid if the agent has access to credit markets. In this paper we generalize the standard PA model to allow for saving and borrowing by the agent. We show that the impact of such access critically depends upon the treatment of default. If default is not permitted, efficiency is strictly reduced by the introduction of credit markets, and the equilibrium level of borrowing or saving is indeterminate in the model. If default is allowed, however, the optimal contract depends upon the level of bankruptcy protection in the economy, which is described by a minimum level of wage income. We show that there is an optimal intermediate range of bankruptcy protection. Within this range, allowing default increases efficiency in the economy relative to the case of no default. Also, the model predicts specific levels of consumer debt, interest rates, and default rates as functions of the level of bankruptcy protection level. Journal of Economic Literature Classification Numbers: D80, G21, G28, J30

We compare institutional execution costs across the major U.S. exchanges using a sample of institutional equity orders in firms that switch exchanges. Execution costs including commissions are essentially indistinguishable across these exchanges. We also find the fraction of trading volume from momentum traders is greater on the NYSE than either the Nasdaq or AMEX and that orders are more likely to be worked by an institution's trading desk on the NYSE than on the Nasdaq. These results suggest that institutions actively manage execution strategies, taking into account characteristics of the markets in which they trade