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Kathryn Judge, Intermediary Influence, 82 U. Chi. L. Rev. 573 (2015).

Prominent economic theories rooted in the seminal work of Ronald Coase have long suggested that firms in a marketplace exist and work to reduce transaction costs, but the explanatory powers of these theories fail to reflect some of the realities of the modern marketplace. In many instances, particularly in the financial industry, it appears that firms exist and work to increase, rather than decrease, transaction costs. In her recent article, Intermediary Influence, Professor Kathryn Judge examines this peculiar phenomenon and offers a persuasive claim that helps to explain this persistent and consequential marketplace curiosity in finance.

The central claim of Professor Judge’s article is aptly summed in the title of the piece: intermediary influence. If one wonders why certain financial arrangements are the way they are, the article suggests the answers likely lies in fees and the firms that collect them. Specifically, the article argues that:

[T]hrough repeatedly helping parties to overcome barriers to transacting, intermediaries develop informational and positional advantages relative to the parties that they serve. These advantages are critical to intermediaries’ capacity to provide value, but they also put intermediaries in a superior position to influence the evolution of institutional forms. In addition, intermediaries of a particular type will often be fewer in number and better organized than the parties that they serve. This makes intermediaries relatively better positioned to shape laws and regulations and to otherwise act to promote institutional arrangements that serve their collective interests. For these reasons, intermediaries often succeed in their efforts to promote and entrench high-fee arrangements.

(P. 590.)

To bolster her claim that certain intermediaries work to add needless transaction costs to the marketplace, Professor Judge offers evidence with case studies of financial intermediaries such as exchanges, stockbrokers, mutual funds, and credit default swap dealers. In each instance, the entrenched intermediary took action that solidified or moved the marketplace toward a high-fee position even when lower cost alternatives seemed viable. Professor Judge suggests that partially as a result of such intermediary influence, the financial industry is less efficient, more intermediated, more complex, and more fragile.

The explanatory strengths of the article are persuasive and powerful. They provide guidance for the current paths of finance, and raise questions about the road ahead. How does one pragmatically and politically go about rechanneling intermediary influence towards greater efficiency and economic welfare mindful of strong incumbent self-interest to oppose such changes? Why have the forces of new technology and greater competition been much more disruptive to entrenched intermediaries in other industries relative to those in finance? What factors make certain intermediary influence more powerful than others? Are there non-economic beneficial purposes to high fees, such as gatekeeping, that we should maintain over time? Are intermediary influence and high fees existential facets of modern finance given its complex and intermediated nature? The answers to these and other lines of inquiries find both fertile ground and green shoots in Professor Judge’s article when one thinks about the large questions looming over the future of financial markets and financial regulation.

Because financial markets are truly markets of intermediaries, financial regulation is truly regulation of intermediaries. And because intermediaries influence, they must be influenced. Thanks to the work of Professor Judge, policymakers and researchers thinking about how best to regulate the financial industry must think harder about how best to repurpose and refashion the influence of financial intermediaries towards more productive and efficient ends.

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Cite as: Tom C.W. Lin, Of Firms and Fees, JOTWELL (July 26, 2016) (reviewing Kathryn Judge, Intermediary Influence, 82 U. Chi. L. Rev. 573 (2015)),