Market manipulation and corporate finance: a new perspective - Review

Financial Management (Financial Management Association), Summer, 1993 by Arkadev Chatterjea, Joseph A. Cherian, Robert A. Jarrow

United States equity and Treasury markets have often been cited in the academic literature as examples of perfectly competitive markets involving numerous buyers and sellers acting as price-takers. Recent academic research, however, has focused on instances where this paradigm fails to hold. In contrast, a copious literature already exists concerning market manipulations in futures markets, which are alleged to be rife with such occurrences. Regulations have since evolved in futures markets to prevent such abuses of market power. Current academic research is now investigating other instances of market manipulation in U.S. equity and Treasury markets and outside the traditional scope of futures markets.

The purpose of the present work is twofold: (i) to review this expanding market manipulation literature and study its implications for financial management, and (ii) to understand corporate finance from a new perspective. This new perspective is obtained by viewing the corporation as an entity participating in financial markets, i.e., as an active, strategic trader manipulating the market to its shareholders' advantage. In addition, the corporation is also viewed as taking certain actions to prevent its shares from being manipulated by others. The insights generated by viewing the corporation in this dual capacity are used to explain many of the phenomena occurring daily in the corporate world.

The first section defines manipulation in general and as applied in particular contexts in financial markets. It contains a categorization scheme for manipulations, and a discussion of various incidents of manipulation in securities markets. The section concludes with a statement concerning our assumptions about the corporation. Section II analyzes the role of the corporation as a manipulator in financial markets. Section III provides new insights into corporate financial management by viewing the corporation as a minimizer of manipulation of its shares by others. Section IV summarizes the views presented herein and concludes the paper.

I. Market Manipulation -- A Preamble

A. Definition of Manipulation

The term "manipulation" has been variously used over the years in the context of financial market regulation. Congress has passed regulations to curtail certain trading practices deemed to be manipulative. For example, the Senate Committee stated in its report on the |Securities~ Exchange Act |of 1934~ that

The purpose of the act is ... to purge the securities exchange of these practices which have prevented them from fulfilling their primary function of furnishing open markets for securities where supply and demand may fully meet at prices uninfluenced by manipulation or control. (As quoted in Goldstein, Ackerson, and Novack |25~.)

Easterbrook |18~ equates "monopoly" in the futures market with "manipulation" and classifies them as a species of fraud.(1) Fischel and Ross |20~ conclude:

Manipulation is a fundamental concern of the regulation of financial markets. But manipulation is not defined in any of the regulatory statutes and, despite much academic and judicial commentary, no satisfactory definition of the term has been offered. In fact, no objective definition of the term exists.(2)

These authors almost assume away the concept of manipulation as it may exist in the real world.(3)

In this paper, we look at the term "manipulation" from a different perspective. The Oxford English Dictionary |43, definition 3.a~ defines "manipulate" as "to manage by dexterous contrivance or influence; especially to treat unfairly or insidiously for one's own advantage." "Manage by dexterous contrivance or influence" captures the essence of the term "manipulation" as defined in the context of this paper.

Anderson |4~ writes:

If we apply a dictionary definition of manipulation to futures markets, we would say it involves cleverly influencing futures prices. This very vague usage does make clear, however that for a manipulation to occur someone (perhaps a group of firms) must have the power to influence market prices.

According to Anderson's classification, models of Anderson and Sundaresan |6~, and Newberry |42~ are models of manipulation where perfect information is assumed and "no particular cleverness is involved; a producer is simply dominant, and he exploits this advantage as best he can." Anderson also states:

Cleverness and power come together in the usage of Chichilnisky |16~ who, following the literature on noncooperative games with imperfect information, considers a market manipulation to be the strategic use of information or market signals. |Italics added~

Jarrow |30~ uses the concept of a large trader, one whose trades influence price, as a manipulator. Even without proprietary information, these traders can sometimes manipulate prices to their advantage and generate profits at no risk. The works cited in this subsection define manipulation in a vein similar to our definition.

B. A Categorization Scheme for Manipulation

Allen and Gale |2~ classify market manipulations into three categories: