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Abstract

How do governance structures emerge in the new institutional structure of the financial system? Since the 1980s, a market-based institutional structure has been developing in parallel with the traditional bank-based structure and has supplanted the traditional system as the dominant source of credit and liquidity for the US economy. The growth of this new parallel system, however, has not been accompanied by a corresponding expansion of the formal laws and regulations that govern economic action. As a result, large sectors of the US economy operate beyond traditional law and regulation and pose systemic risks to the broader economy and society. This article identifies and explicates the governance mechanisms that have emerged in one of the four major markets in the new parallel system—the U.S. hedge fund market—and the failures thereof. The empirical data for this study come from three years of fieldwork, 40 semi-structured interviews with expert informants, and eVestment|HFN database. This article advances the multilevel causal model developed by new institutionalism in economic sociology, with research findings that suggest that (1) the emergence of a governing social order is the result of interactions between the formal institutional environment regulating the traditional financial system and the social relations, informal norms, and institutionalized practices of interest-driven parallel financial organizations, and (2) governance failures emerge at specific locations where the formal institutional environment and the informal set of institutional and social structural governance mechanisms break down.