Prediction Markets and Corporate Governance

31 October 2006 at 10:05 am Peter G. Klein 1 comment

| Peter Klein |

Prediction markets have generated a lot of buzz (particularly in the econo-blogosphere). A new paper by Michael Abramowicz and Todd Henderson explores the potential role of prediction markets in corporate governance. The authors are enthusiasts:

Prediction markets can increase the flow of information, encourage truth telling by internal and external firm monitors, and create incentives for agents to act in the interest of their principals. The markets can thus serve as potentially efficient alternatives to other approaches to providing information, such as the Sarbanes-Oxley Act’s internal controls provisions. Prediction markets can also produce an avenue for insiders to profit on and thus reveal inside information while maintaining a level playing field in the market for a firm’s securities. This creates a harmless way around existing insider trading laws, undercutting the argument for the repeal of these laws. In addition, prediction markets can reduce agency costs by providing direct assessments of corporate policies, thus serving as an alternative or complement to shareholder voting as a means of disciplining corporate boards and managers.

For caveats and qualifications regarding the ability of prediction markets to replace entrepreneurial judgment, see this technical report and this non-technical, critical assessment.