A Transaction Price Is Not a Clearing Price:
The Two Information Problems in Private Markets

At a glance: Private markets face two information gaps: understanding asset quality and discovering what competing capital providers will pay. A completed transaction answers neither question on its own. This article examines how effective intermediation can improve price discovery, and why intermediaries must also earn their fees and address their own incentive conflicts.

The Information Problem Financial Intermediation Is Supposed to Solve

Capitalism works, in large part, because better products and services are supposed to earn better economics. Build a better product and customers should pay more for it, buy more of it, or both. That reward encourages producers to improve, competitors respond, and capital gets allocated toward the companies producing better outcomes.

But there is an important condition buried inside that mechanism: the market has to be able to recognize quality.

If buyers cannot distinguish a good product from a bad one, they will not reliably pay a premium for the good one. And if nobody pays up for quality, eventually the people producing quality stop offering it.

That is the deeper insight behind George Akerlof's work on quality uncertainty, and, in my view, one of the most important economic arguments for financial intermediation.

The point becomes more important still in private financial markets, where participants often face a second problem beyond simply identifying quality. They may not know the true clearing price of the asset or of the capital.

That changes everything.

Why Nobody Pays Up

In 1970, economist George Akerlof published The Market for "Lemons": Quality Uncertainty and the Market Mechanism. His example was the used car market.

The seller knows whether the car being offered is a good car or a lemon. The buyer does not.

The buyer understands that disadvantage and responds rationally. Instead of paying a price appropriate for a very good car, the buyer discounts the price to account for the possibility that the car might be a bad one.

Now consider the owner of a genuinely good car. He knows what he owns. If the market will only offer him a price based on the average quality of all the cars being offered, he may decide not to sell.

The good cars begin disappearing from the market. Average quality deteriorates. Buyers become more cautious. Prices fall further. The process feeds on itself.

The important insight is not simply that buyers and sellers possess different information. It is that information asymmetry prevents quality from being properly priced. And when quality cannot be properly priced, one of capitalism's core incentive mechanisms begins to break down.

I Have Watched This Happen in the Classroom

I have run versions of the lemons exercise with students on and off for roughly ten years, at Columbia University's School of Professional Studies and elsewhere. Students are divided into buyers and sellers and given different information about the assets they are trading.

The results are remarkably consistent.

Buyers quickly recognize that sellers know more than they do, and they respond rationally by protecting themselves on price. The better sellers know they have better assets, but simply saying, "Trust me, mine is better," does not solve the problem. So the better sellers become reluctant to transact at the prices buyers are willing to offer.

Then we introduce intermediation. Every time I have run the exercise, execution improves.

That is a classroom observation, not scientific proof. But I think the reason is revealing.

Once quality can be recognized, quality can be priced. Once price can be discovered, better sellers have a reason to participate.

Finance Has the Same Problem

Consider two lenders, each offering investors a $100 million portfolio.

One lender has disciplined underwriting, strong servicing, conservative verification standards, stable vintages and a management team with a consistent history of credit performance. The other does not.

If investors can confidently distinguish between them, capitalism should do what capitalism is supposed to do. The better portfolio should receive better economics. That could mean a higher purchase price, a lower required yield, a higher advance rate, less credit enhancement, better financing terms, or some combination of those things. The market is rewarding the better producer.

But what happens if investors cannot confidently distinguish between the two?

They protect themselves.

Was underwriting recently loosened? Has servicing changed? Were certain loans removed before the portfolio was marketed? Why is the lender selling now? Does management know something about future performance that the investor does not?

The investor responds to those uncertainties by increasing the return it requires.

In other words, nobody pays up.

And the lender with the best assets eventually says exactly what the owner of Akerlof's good used car says: at that price, I am not selling.

That is the lemons problem in financial markets.

Private Markets Make the Problem Harder

The problem becomes more acute in private markets because there is often no observable clearing price.

In public markets, information is imperfect, but there are usually external reference points. Participants can observe recent trades, compare secondary market levels, review new issue concessions, and look at comparable securities, dealer runs, ratings, research and market screens. None of those mechanisms is perfect. Together, however, they create a framework for price discovery.

Private markets frequently do not have that framework.

An issuer may receive a bid of 92 and have no idea whether another investor would have paid 96. A borrower may receive a financing proposal at the Secured Overnight Financing Rate plus 650 basis points and have no idea whether another lender would have offered the same structure at plus 550. An investor may pass on an asset because it does not fit its portfolio, while another investor with a different liability structure might value that same asset considerably more highly.

The parties may execute a transaction. But that does not necessarily mean they discovered the price at which the asset would have cleared against the full universe of capital that might have wanted it.

A private asset can clear at 94 simply because only one serious investor evaluated it. In a narrow sense, 94 cleared that particular negotiation. It tells us there was a buyer at 94. It does not tell us that another credible investor would not have paid 97, or that 94 was the best executable price available in the market.

There is a further difficulty that receives very little attention. In public markets, a poor execution is at least visible after the fact. The next print corrects it, and the participant learns something. In private markets, there frequently is no next print. The transaction becomes the only observation that will ever exist for that asset, which means a seller can leave two points on the table and never discover that it happened.

There Are Really Two Information Problems

Private transactions therefore involve at least two forms of information asymmetry.

The first is familiar. How good is the asset?

The seller knows the underwriting history, knows how the credit box has changed, knows where servicing has improved or deteriorated, knows which vintages concern management, and knows why performance looks the way it does. It also knows something particularly important. It knows why it wants to sell. The investor does not know all of that.

But there is a second problem. What is the asset actually worth to the available universe of capital?

The investor knows its own cost of capital, what competing opportunities it is evaluating, how much capacity it really has, and how aggressively it wants to deploy. It knows whether a structural change would materially improve its economics. And it knows whether its first bid reflects fair value, or simply the lowest price it believes the issuer might accept. The issuer generally does not know those things.

So the seller knows something about the asset that the buyer does not. The buyer knows something about the price of capital that the seller does not. Both sides are negotiating across an information gap.

That is why simply introducing them does not necessarily produce the best outcome.

Neither Side Can See the Cross Section

Both of those problems share a feature that is easy to miss. They are not problems of competence. They are problems of position.

An issuer with twenty investor relationships observes twenty bilateral relationships, and every one of them was shaped by its own assets, its own timing and its own negotiating history. It does not observe how those same investors behaved on somebody else's paper. It does not know which of them paid up for quality when quality was demonstrated, which of them consistently reprice after diligence, which of them will accept a structural change to improve their economics rather than simply lowering the price, and which of them decline far more often than they execute.

The investor faces the mirror image. It knows its own cost of capital, its own preferred structure and its own return requirement. What it does not know is how any of those compare to the investors it is competing against for the same risk. It may be bidding well ahead of the market and paying more than it needed to. It may be bidding behind the market and losing assets it genuinely wanted. Its own history tells it what it has done. It does not tell it what everyone else did.

Neither party can solve this by working harder or by hiring better people. The information does not exist inside either firm, because neither firm occupies a position from which it can be observed.

An intermediary that runs many processes across the same universe of capital does occupy that position. It observes how different pools of capital respond to the same risk, which structures particular investors prefer and why, where indications tend to hold and where they tend to erode after diligence, and which counterparties actually execute rather than merely engage. That accumulated cross section is not a substitute for the tape that public markets enjoy. But it is the closest thing private markets have to one.

It is worth being clear about what that knowledge is and is not. It does not depend on carrying confidential information from one client into another process, and an intermediary that operated that way would not last long enough to accumulate anything. It comes from repeated observation of market behavior across many transactions: which structures tend to work, where capital tends to price particular risk, how objections evolve through diligence, who executes, and how different liability structures value the same asset differently.

That is what makes a transaction something other than purely bilateral. Without it, an issuer and an investor negotiate with only two vantage points in the room, and both of them are partial.

Price Discovery Is Information Discovery

This is especially important because private markets tend to confuse access with price discovery.

Finding 500 investors solves an access problem. Sending those investors a data room solves a distribution problem. Providing a 150 column loan tape solves a data availability problem. None of those things necessarily solves the information problem, and none of them necessarily solves the price discovery problem.

More data does not automatically create more understanding. More investor names do not automatically create a market.

Someone still has to determine which variables actually matter, and whether a change in performance represents seasoning, underwriting drift or genuine deterioration. Someone has to know whether a low bid reflects credit concerns or simply an inefficient structure, and which form of capital values a particular asset most highly. Someone has to distinguish an investor who is interested from an investor who can actually execute, and recognize when competition is real and when it is merely cosmetic.

In private markets, price discovery is itself a form of information discovery.

Until multiple credible pools of capital evaluate the same risk, the issuer may not know what its assets are actually worth. And until investors understand the quality of the asset, they may not be willing to reveal their best price. The two problems reinforce one another.

Going Direct Is in Fashion

This matters because do it yourself financing is increasingly fashionable on both sides of the market. Large investors have built direct origination teams. Private credit managers source transactions themselves. Issuers increasingly maintain their own investor relationships.

Technology makes identifying counterparties easier than ever. A company can populate a data room almost instantly, analytics can process enormous loan tapes, and artificial intelligence will make that process faster still.

The argument for going direct is understandable. The issuer asks why it should pay an intermediary when it knows its own business and its own assets better than anyone. The investor asks why it needs an intermediary when it has its own analysts, models and relationships.

Sometimes they are absolutely right.

But there is a subtle problem with the issuer's argument. "I know my assets better than anyone" does not eliminate information asymmetry. It is almost the definition of information asymmetry.

And "I already know investors" does not necessarily mean the issuer knows the clearing price of capital. That is a different problem entirely.

What the Research Adds

This question sits at the center of an interesting paper by Zachary Bethune of the University of Virginia, together with Bruno Sultanum and Nicholas Trachter of the Federal Reserve Bank of Richmond, titled An Information Based Theory of Financial Intermediation. The authors examine decentralized markets and ask why certain participants become important intermediaries.

Their answer is that the central players are what they call screening experts, meaning participants with a superior ability to evaluate information and understand the trading motives of their counterparties. Those participants interact with more counterparties, account for more trading volume and perform more intermediary activity. The authors then find transaction level evidence consistent with those predictions.

That offers a very different way of thinking about intermediation. The intermediary does not become valuable because it occupies a position between two parties. It becomes valuable because it is better at understanding what those parties know, what they want, and whether there is a transaction that produces gains for both. In private markets, that includes not only evaluating the asset. It includes understanding how different pools of capital value the same risk.

The Intermediary Should Have to Earn Its Economics

There is an uncomfortable implication here for our own industry.

If all an intermediary does is forward an email from an issuer to an investor, the parties have every right to ask what economic value has been created. Knowing somebody's telephone number is not financial intermediation. Neither is simply distributing a data room.

A capable intermediary should help the market distinguish one opportunity from another. It should understand the assets well enough to challenge the issuer, and understand the capital well enough to recognize whether an objection is fundamental or structural. It should distinguish an indicative conversation from executable capital. It should understand comparable transactions and know which investors are likely to value a particular asset most highly. It should create competition where competition can improve execution, help investors recognize quality when quality exists, and help issuers understand when the market is correctly identifying a weakness they would rather ignore.

Sometimes good intermediation should result in a higher price. Sometimes it should result in a lower cost of capital. Sometimes it should produce a better structure. Sometimes it should simply create greater certainty of execution. And occasionally, good intermediation should lead everyone to conclude that the transaction should not happen at all.

If an intermediary cannot improve any of those outcomes, going direct may indeed be the better answer.

The Intermediary Has Its Own Incentive Problem

There is a fair objection to everything written so far, and most experienced institutional investors will raise it immediately.

The intermediary is not a neutral party. It is a participant with its own information advantage and its own economic interest, and that interest is not perfectly aligned with either side. In most engagements the intermediary is paid when a transaction closes. That creates an obvious tension. The party arguing that price discovery is valuable is the same party that gets paid only if a price is ultimately accepted.

Investors understand this well. Many have participated in a process where the competition turned out to be largely cosmetic, where the stated interest of other bidders could not be verified, and where urgency was manufactured rather than real. Issuers understand it too. They have received advice to accept a bid and wondered whether that advice reflected genuine market judgment or a desire to close.

I do not think the objection can be dismissed. I think it has to be answered.

The strongest answer is not a claim about character. It is a claim about economics.

The cross sectional knowledge described earlier is a repeat player asset. It accumulates only because counterparties on both sides continue to bring the intermediary into processes, and continue to engage candidly when they do. An intermediary that manufactures competition, or pushes an issuer toward a bid the market does not support, degrades precisely the standing that produces that access. The fee available on any single transaction is small relative to the value of remaining a party that both sides are willing to deal with openly.

That is why the incentive is better aligned than the fee structure alone would suggest. A one time participant paid at closing has every reason to force a close. A participant whose principal asset is what it learns across many transactions has every reason to protect its standing with both sides, even at the cost of a particular deal.

None of that makes the tension disappear entirely, and an issuer or an investor is right to test it rather than assume it. The evidence is not found in the pitch. It is found in whether the intermediary tells an issuer that its expectations are unrealistic, whether it identifies a weakness in the assets before an investor does, whether it describes competing interest accurately rather than favorably, and whether it is willing to recommend that a transaction not proceed.

Those behaviors are costly in the short term. An intermediary that recommends against a transaction is declining a fee. That is precisely why they are informative. In a market where quality is difficult to observe, the most reliable signal is a demonstrated willingness to act against one's own immediate economic interest.

Which is, in a sense, the same lesson Akerlof teaches. The owner of the good used car needs some credible way to show that the car is good. So does the intermediary.

Disintermediation Can Be More Expensive Than It Looks

That leads to what I believe is the real trade off behind do it yourself financing.

Going direct can reduce explicit transaction costs. There is no question about that.

But it is worth being precise about what going direct actually eliminates. It does not eliminate the function. Screening, structuring, price testing and process management still have to happen. Going direct relocates that work inside the firm, which means the market pays for it twice, once on the issuer side in the form of a capital markets team and once on the investor side in the form of an origination team.

That duplicated layer carries a utilization problem. An intermediary maintains its capability as a fixed cost spread across many transactions and many counterparties. An in house team carries a comparable fixed cost and uses it intermittently. An issuer that comes to market twice a year is maintaining a capability that sits idle for most of the year, and that cost does not disappear between transactions. It simply stops being visible, because compensation, systems and data subscriptions do not appear in the fee comparison the way a placement fee does.

The in house team also faces the positional problem described earlier. A group that runs two processes a year observes two processes a year, all of them on its own assets. The people may be entirely capable, and some of the largest and most active participants in these markets have genuinely deep internal knowledge of where capital prices risk. The position simply does not generate that information on its own. For many issuers, going direct can therefore mean paying a higher effective cost per transaction in exchange for a structurally narrower view of the market.

But suppose eliminating the intermediary saves an issuer 50 basis points in fees, while inadequate price discovery causes that issuer to accept a price 200 basis points below what a broader and better informed market would have produced.

Was the intermediary expensive? Or was eliminating the intermediary expensive?

This is where traditional discussions of fees become misleading. The relevant question is not simply what does the intermediary cost? The better question is what does the absence of effective intermediation cost?

If a capable intermediary allows quality to be recognized and the market clearing price to be better discovered, the difference can be substantial.

The Better Question

I therefore do not think the right question for modern private markets is do we still need intermediaries?

The better question is does the intermediary improve the market's ability to recognize quality and discover price?

If the answer is no, the parties are better off transacting directly. If the asset is standardized, pricing is transparent, both parties possess similar information and there is a readily observable market, there may be little economic value in adding another participant.

But when assets are complicated, information is unevenly distributed, markets are fragmented and competing prices are not observable, the answer can be very different.

Capitalism rewards quality only when the market can recognize it. Private markets reward quality only when the price of that quality can be discovered. A completed transaction proves that somebody was willing to transact. It does not necessarily prove what the market would have paid.

Akerlof showed what happens when the first mechanism breaks down. Private markets demonstrate why the second matters just as much.

I have watched versions of the problem play out repeatedly in the classroom. And more than fifty years after Akerlof, research into financial market structure suggests that the most useful intermediaries are precisely those participants best able to screen information and understand the parties on either side of a transaction.

At QueensGiant, that is how we think about the job. Our role is not simply to introduce capital to assets. We expose an asset to credible pools of capital with genuinely different liability structures, return requirements and reasons to want that particular risk, because that is one of the most reliable ways to learn what the market will actually pay rather than what a single investor happens to be willing to pay.

Because in private markets, the challenge is not simply figuring out whether the asset is good.

It is figuring out what good is actually worth.

And if the market cannot do that, nobody pays up.