INEFFICIENCIES AND MARKET POWER IN FINANCIAL ARBITRAGE: A STUDY OF CALIFORNIA'S ELECTRICITY MARKETS*

For two years prior to the collapse of California's restructured electricity market, power traded in both a forward and a spot market for delivery at the same times and locations. Nonetheless, prices in the two markets often differed in significant and predictable ways. This apparent inefficiency persisted, we argue, because most firms believed that trading on inter‐market price differences would yield regulatory penalties. For the few firms that did make such trades, it was not profit‐maximizing to eliminate the price differences entirely. Skyrocketing prices in 2000 changed the major buyers' (utilities') incentives and exacerbated the price differentials between the markets.     

Private Equity and Local Public Finances

We study the economic impact of private equity (PE) investments on local governments, which are important corporate stakeholders. Examining over 11,000 deals and private firm data in Europe, we document that target firms' effective tax rates and total tax expenses decrease by 15% and 13% after PE deals. At the same time, target firms expand their capital expenditures and firm boundaries, but do not increase employment. Using administrative data on the public finances of German municipalities and exploiting the geographical and time-series variation in PE deals, we document that PE activity is negatively associated with local governments' tax revenues and spending. This result is likely driven by reduced tax payments of PE portfolio firms, accompanied by only modest positive spillovers of PE investments on regional economic growth. Collectively, our findings suggest that corporate tax efficiency serves as a cost-cutting channel in the PE sector and constrains the finances of local governments.