From Volume 77, Number 2 (January 2004)
Securities markets are commonly assumed to spring forth at the intersection of an adequate supply of, and a healthy demand for, investment capital. In recent years, however, seemingly failed market transitions—the failure of new markets to emerge and of existing markets to evolve—have called this assumption into question. From the developed economies of Germany and Japan to the developing countries of central and eastern Europe, securities markets have exhibited some inability to take root. The failure of U.S. securities markets, and particularly the New York Stock Exchange, to make greater use of computerized trading, communications, and processing technologies, meanwhile, seems to suggest some market resistance to technological modernization. In light of this pattern, one must wonder: How are strong markets created and maintained, and what might be law’s role in this process?
This Article attempts to articulate a model for understanding the needs of efficient market transition and the resulting role of law in that process. Specifically, it suggests a “cueing” function for law in market transition. Grounded in largely ignored lessons of game theory and in the microeconomic analysis of so-called network effects, cueing theory identifies the coordination of market participants’ expectations as law’s central role in market transition. Building on recent legal literature on private regulation, social norms, and the expressive function of law, this theory suggests that in securities market transition—whether it be market creation in central and eastern Europe or market restructuring in the United States—law primarily serves to convene, encourage, inform, and facilitate.
A cueing role for law constitutes an important extension of traditional conceptions of what law does, particularly in securities regulation, but in other areas as well. Regulatory cues are neither coercive nor outcome determinative and involve a close intertwining of public and private regulation. The exceptional character of law in this context, and the recent growth in areas where regulatory cues might have fruitful application, may explain why such a role has not previously been analyzed. Yet in securities markets and other industries exhibiting network economies—from electricity transmission and interstate transportation to telecommunications and the Internet—a cueing function for law may be central to efficient transition. It may explain much of why “law matters” in the modern economy.