On Restructuring the NYSE: Might a Nonprofit Stock Exchange Have Been Efficient?

27 Pages Posted: 8 Dec 2011 Last revised: 16 Dec 2011

See all articles by Jennifer W. Kuan

Jennifer W. Kuan

Tulane University - A.B. Freeman School of Business

Stephen F. Diamond

Santa Clara University - School of Law

Date Written: October 1, 2006

Abstract

This spring the New York Stock Exchange, Inc. (NYSE) completed an historic restructuring. On March 7, 2006, the NYSE completed its merger with Archipelago Holdings Inc. (Archipelago), a publicly traded electronic trading platform. As a result, the old NYSE itself will become the New York Stock Exchange LLC, a wholly owned subsidiary of NYSE Group, Inc. (NYSE Group). The former members, or seat holders, of the NYSE will receive one of three forms of consideration: all cash, all stock in NYSE Group, or a package of cash and stock. Then, NYSE Group will allow those former members to offer their shares to the public in a secondary offering.

Because the NYSE was a not-for-profit corporation, the merger was also a change in organizational form. The change from nonprofit to for-profit, or demutualization, has mostly been viewed as a long-overdue response to new, on-line competition from electronic communications networks (ECN's). But there has been little assessment of the strengths or efficiencies of the nonprofit form of the exchange. This paper presents the possibility that the NYSE's choice of form was an efficient solution to a classic lemons problem, in which misinformation from bad issuing firms (firms whose shares trade on the exchange) could drive out good issuing firms. We apply a robust theory of nonprofits in which the highest demanding consumers of a nonrival good organize the production of that good. In this case, investment bankers and other financial intermediaries organize to produce liquidity. The resulting nonprofit is the former NYSE, which was able to align issuing firms' incentives to disclose with those of investors. Banker-owners of the NYSE acted as gatekeepers to the exchange, screening issuing firms through an extensive due diligence process, providing capital via underwriting, and connecting issuing firm insiders to one another via initial public offering (IPO) allocations. Over a period of many decades this system maintained an equilibrium in which issuing firms, big and small investors, and exchange members could participate with relative ease, transparency and fairness in the exchange. The shift to a for-profit corporation will have a significant, and potentially deleterious, impact on this equilibrium as it breaks up the longstanding components of the nonprofit system.

Keywords: demutualization, stock exchange, nonprofit, hostages

JEL Classification: G14, G24, G34, L31

Suggested Citation

Kuan, Jennifer W. and Diamond, Stephen F., On Restructuring the NYSE: Might a Nonprofit Stock Exchange Have Been Efficient? (October 1, 2006). Santa Clara Univ. Legal Studies Research Paper No. 06-15, Available at SSRN: https://ssrn.com/abstract=891268 or http://dx.doi.org/10.2139/ssrn.891268

Jennifer W. Kuan (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Stephen F. Diamond

Santa Clara University - School of Law ( email )

500 El Camino Real
Santa Clara, CA 95053
United States

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