The Eccentric Entrepreneur’s Venture
Suppose an eccentric entrepreneur is raising money for a new venture. It could be a sort of metaverse hula hoop or some revolutionary way of financing a public good (in the economic sense) or whatever. He tells potential adult investors something like:
You know I am an eccentric genius. If my idea works, you and I will make piles of money; if it does not work, I will not gain anything and you will lose your investment. According to my estimates and my entrepreneurial intuition, I think there is a good chance of the former. As you suspect I will run my baby as I want and your only real recourse if you are not happy will be to sell your participation if you can find a buyer.
We may further imagine that the state under which the eccentric investor lives actually does want to increase information and reduce transaction costs in investment decisions—more than, say, deepen its surveillance and control powers. Recall that transaction costs are the costs of finding contractual partners, agreeing with them, enforcing the agreements, and such. Our ideal government has decreed that all corporations who offer the sort of caveat emptor conditions described above will have to append “EE” (for “Eccentric Entrepreneur”) to their corporate names. We may conjecture that this legal rule would meet Friedrich Hayek’s requirement that any new rule be consistent with the general system of rules of the spontaneous order of a (more or less) free society. Our eccentric investor creates an EE corporation through with he raises money from investors.
In one case or the other, any adult is free to invest or not to invest and, of course, to refuse to patronize any third party who does (conservative bankers are likely to abstain). Suppose that, Mr. A or Ms. B, “natural equals” in James Buchanan’s terminology, or hedge fund C, whose own investors are natural equals as well, decides to invest money in our eccentric entrepreneur’s venture. What is the problem with this voluntary exchange?
If nobody chooses to risk his money, there is no problem either, and no reason for the state to encourage investment by making people believe that there is no risk because of its benevolent regulation.
One objection (typical of the Law & Economics school) is that the state can find other ways to further reduce transaction costs in order to compensate for the fact that the eccentric investor has more information about his venture than the potential investors do—the asymmetric information argument. For example, the state could force eccentric entrepreneurs to regularly publish detailed and verified financial statements of their ventures. One problem with this sort of informational mandate is that they tend to grow non-stop over time, in volume and scope, as we have seen since the early 20th century. The more powerful “the regulator” becomes, the higher are the transaction costs that citizens face in their relations with their own government.
A related idea worth remembering has been succinctly expressed in Geoffrey Brennan and James Buchanan’s book The Reason of Rules:
There is no necessary presumption that simply because markets are imperfect, political processes will work better.