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A Political Theory of Corporate Crime Legislation
Vikramaditya S. Khanna
April
2003Corporate crime has once again become an important issue on the US legislative agenda. Following the recent economic downturn and the spectacular revelations of corporate wrongdoing, Congress and the various regulatory bodies have begun to tighten the law and enhance honesty and completeness in disclosure. The enactment of the Sarbanes-Oxley Act of 2002 is one example and adds to the already sprawling area of corporate criminal liability. However, the continued and rather explosive growth of corporate crime legislation leaves one with a rather strange puzzle: how can such a state of the world arise? After all, corporations and business interests are considered some of the most powerful and effective lobbyists, if not the most effective and powerful, in the country. Yet, we witness the continued expansion of legislation that criminalizes some of their behavior (one estimate suggests over 300,000 federal regulatory offenses that can be prosecuted criminally). How could this have happened given that business interests should be able to lobby to protect themselves? This paper sets out to answer this puzzle.
An answer is important not only for purposes of understanding the political dynamics of current regulation, but also because it provides insights into the effectiveness of our current approach for regulating corporate wrongdoing. Overall, my analysis suggests that corporate criminal liability – the imposition of criminal sanctions on the corporate entity – serves little deterrent or expressive function above that offered by corporate civil liability. This suggests, on first glance, weak support for the growth of corporate criminal liability. However, this is only on first glance. Indeed, on closer inspection, it appears that corporate criminal liability imposes relatively low costs on corporate interests, may help to avoid legislative and judicial responses that are more harmful to their interests, and may at times help to deflect criminal liability away from managers and executives and on to corporations. These effects may often benefit corporate interests and weakens their opposition to corporate crime legislation. In light of this, the growth of corporate crime legislation becomes more understandable. This not only provides some explanations for the impressive growth of corporate criminal liability, but also leads to some interesting normative conclusions. In particular, it leads to the counter-intuitive result that if one starts with the view that there is under-deterrence of corporate wrongdoing then one would probably prefer to reduce corporate criminal liability and focus more on corporate civil liability and managerial liability.
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Re-examining Legal Transplants: The Director's Fiduciary Duty in Japanese Corporate Law
Hideki Kanda and Curtis J. Milhaupt
March 24, 2003
The transplantation of legal rules from one country to another is commonly observed around the world. Legal transplants can range from the wholesale adoption of entire systems of law to the copying of a single rule. Despite the importance of transplants to legal development around the world, scholarly understanding of this ubiquitous form of legal development is still fairly rudimentary. For example, there is little agreement among scholars on transplant feasibility and the conditions for successful transplants, or even how to define "success." Moreover, there is little analysis of how the success or failure of legal transplants relates to the achievement of larger goals, such as economic development.
Japanese law, particularly the legal rules governing economic organization, is a prime example of the transplant phenomenon, both in its systemic and single-rule variations. Japan imported its original Commercial Code (including legal rules on business corporations) from Germany in 1898 as part of a fundamental reform of its legal system, and made large-scale amendments to the corporate law in the immediate post-war period by importing many specific legal rules from the United States. This article attempts to shed light on the role of legal transplants in corporate law by examining Japan's transplantation of a single corporate rule: the director's duty of loyalty, which was added to the Commercial Code in 1950 as a direct import from the United States. For almost forty years after it was transplanted, however, the duty of loyalty was never separately applied by the Japanese courts, and played little role in Japanese corporate law and governance. It finally began to be used in the late1980s, long after Japan had achieved high economic growth. Using a simple theory of legal transplants, we explain the initial non-use and subsequent use of the duty of loyalty transplant in Japanese corporate law.
Part I of the paper provides a simple analytical framework for determining the success or failure of a legal transplant. Part II takes up the specific case study of the transplantation of the duty of loyalty into Japanese corporate law. It begins with a brief examination of the central role of duty of loyalty doctrine in U.S. corporate law. We then contrast the situation under Japanese corporate law, tracing the duty of loyalty from its transplantation to its eventual application by the Japanese courts. Part III evaluates the transplantation of the duty of loyalty in Japan in light of our theoretical discussion.
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Nonprofit Organizations as Investor Protection: Economic Theory, and Evidence from East Asia
Curtis J. Milhaupt
March 10, 2003
Enforcement problems plague shareholder activism and investor protection in many parts of the world. The importance of solving this problem has led scholars to consider a range of partial alternatives to weak domestic corporate law enforcement regimes, ranging from writing "self enforcing" corporate laws to using cross listings on foreign stock exchanges as a means of bonding firms to higher quality enforcement.
The recent experience of the three largest capitalist market economies of East Asia suggests that there is another partial solution to the problem of weak investor protection and corporate law enforcement, one that has received no theoretical or empirical attention—the nonprofit organization. This partial solution emerges from a puzzle at the center of contemporary East Asian corporate governance. With the possible exception of the government itself, nonprofit organizations (NPOs) have emerged as the most important corporate law enforcement agents in Korea, Japan and Taiwan. In each system, an NPO holding a portfolio of shares is engaged directly in the exercise of shareholders’ rights to combat corporate fraud and mismanagement, and to improve the investor protection climate. In numerous instances, these organizations have won significant court victories or settlements against management. This development is puzzling because the defining characteristic of an NPO is the nondistribution constraint. That is, while nonprofits are not prohibited from making profits, they are prohibited from distributing them to their owners. Why are three organizations operating within the nondistribution constraint—rather than institutional investors or individual shareholders represented by plaintiffs’ attorneys—the principal shareholder activists cum corporate law enforcement agents in this region?
This paper analyzes the role of NPOs in East Asian corporate governance, and applies economic theory on the existence of nonprofits as suppliers of public goods (along with several complementary theories) to explain the rise of NPOs as suppliers of investor protection in the region. The paper also examines the academic and policy implications of the East Asian experience. Academically, the NPO as a corporate law enforcement mechanism is a highly distinctive illustration of functional convergence in corporate governance: several societies have spontaneously generated substitutes for the attorney-oriented incentive mechanisms relied upon in the United States to enhance investor protection. Yet each NPO displays its own unique structure and strategy, differences that can be tied directly to the distinct domestic legal and political structures in which they operate. At the level of law reform, for transition economies the NPO has several advantages as a corporate law enforcement device, particularly in societies reluctant or unable to transplant the U.S. "attorney as bounty hunter" model of law enforcement. First, the nondistribution constraint inherent in the NPO form provides a built-in check on frivolous litigation. Second, shareholder activist NPOs seek to use and improve local law enforcement institutions, while most of the alternatives discussed in the literature involve abandoning weak local enforcement regimes.
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Market Bubbles and Wasteful Avoidance: Tax and Regulatory Constraints on Short Sales
Michael R. Powers, David M. Schizer and Martin Shubik
March 24, 2003
Although short sales make an important contribution to financial markets, this transaction faces legal constraints that do not govern long positions. In evaluating these constraints, other commentators, who are virtually all economists, have not focused rigorously enough on the precise contours of current law. Some short sale constraints are mischaracterized, while others are omitted entirely. Likewise, the existing literature neglects many strategies in which well advised investors circumvent these constraints; this avoidance may reduce the impact of short sale constraints on market prices, but may contribute to social waste in other ways. To fill these gaps in the literature, this paper offers a careful look at current law and draws three conclusions. First, short sales play a valuable role in the financial markets; while there may be plausible reasons to regulate short sales– most notably, concerns about market manipulation and panics – current law is very poorly tailored to these goals. Second, investor self-help can ease some of the harm from this poor tailoring, but at a cost. Third, relatively straightforward reforms can eliminate the need for self-help while accommodating legitimate regulatory goals. In making these points, we focus primarily on a burden that other commentators have neglected: profits from short sales generally are ineligible for the reduced tax rate on long-term capital gains, even if the short sale is in place for more than one year.
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Governance Failures of the Enron Board and the New Information Order of Sarbanes-Oxley
Jeffrey N. Gordon
March, 2003
(Prepared for the University of Connecticut Law Review
Symposium
Crisis in Confidence: Corporate Governance and Professional Ethics
Post-Enron)
This paper argues that the principal governance failure of the Enron board was to approve a disclosure policy that made the firm
's financial results substantially opaque to public capital markets, despite also approving a compensation strategy that made managerial payoffs highly sensitive to stock price changes and despite its unwillingness to engage in intense monitoring of business results and financial controls. In comparable circumstances of constrained monitoring by public markets, LBO firms and venture capitalists undertake a vigorous monitoring role. Important provisions of the Sarbanes Oxley Act can be seen as correcting for a public board's probable inability to adequately monitor a complex corporate finance strategy, "corrective disclosure." But the Act also seems to contemplate immediate disclosure of material business developments even in circumstances where premature disclosure may well sacrifice shareholder value for very little gain in capital market efficiency. The paper criticizes such "price- perfecting disclosure." A further consequence of the Act's disclosure regime may be to shift governance authority away from management and the board toward shareholders, including in the case of hostile takeovers.Keywords: corporate governance, Enron, Sarbanes-Oxley, takeover
law
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Law, Rules, and Presidential Selection
Samuel Issacharoff
February
, 2003Robert Dahl, in "How Democratic is the American Constitution?" criticizes the
institution of the Electoral College as "morally, politically, and
constitutionally wrong." This Article addresses the third of those claims.
Dahl’s critique, like many directed against the Electoral College, presumes a
constitutional commitment to majoritarianism. This Article examines the rather
commonplace departures from strict majoritarian rule in the Constitution, and
concludes that the distortions from majoritarian preferences created by the
Electoral College are actually much smaller in scope than those created by the
U.S. Senate, the Article V amendment process and, to some extent, the House of
Representatives. Moreover, subsequent constitutional developments—namely the
"Reapportionment Revolution" of Baker v. Carr and later cases—have not enshrined
a constitutional principle of simple majoritarianism that might undermine the
constitutional foundation of the Electoral College. The Article then explores
the controversies surrounding the presidential elections of 1800 and 1876 to
argue that there are nonetheless important constitutional principles at stake in
the operation of the Electoral College, namely in the manner in which Congress
dictates rules for the settlement of disputes arising from presidential
elections. The Article concludes by discussing one aspect of the Electoral
College that could be susceptible to constitutional challenge: the
"winner-take-all" system employed by nearly all states to allocate electoral
votes. This practice, which is not mandated by the Constitution, could be
challenged, not on the grounds that it is inconsistent with majoritarianism, but
rather on the grounds that it gives the majority too much power—an argument that
finds much stronger support in our constitutional jurisprudence.
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What Caused Enron?: A Capsule Social and Economic History of the 1990's
John C. Coffee, Jr.
January 20, 2003
Between January 1997 and June 2002, approximately 10% of all listed companies in the United States announced at least one financial statement restatement. The stock prices of restating companies declined 10% on average on the announcement of these restatements, with restating firms losing over $100 billion in market capitalization over a short three day trading window surrounding these restatements. Such generalized financial irregularity requires a more generic causal explanation than can be found in the facts of Enron, WorldCom or other specific case histories.
Several different explanations are plausible, each focusing on a different actor (but none giving primary attention to the board of directors):
1. The Gatekeeper Story looks to the professional
Areputational intermediaries@ on whom investors rely for verification and certification - - i.e., auditors, analysts, debt rating agencies and attorneys - - and views the surge in financial restatements as the product of both (a) reduced legal exposure for gatekeepers (as the result of legislation and judicial decisions in the 1990's sheltering them from liability) and (b) the increased potential for consulting income or other benefits from their clients (resulting in gatekeeper acquiescence in accounting or financial irregularities). This is essentially the story to which the Sarbanes-Oxley Act responds.2. The Misaligned Incentives Story instead focuses on managers and a dramatic change in executive compensation during the 1990's, as firms shifted from cash to equity-based compensation. Stock options (and legal changes that enabled management to exercise the option and sell the security without any delay) arguably gave management a strong incentive to inflate reported earnings and create short-term price spikes that were unsustainable, but which they alone could exploit. Sarbanes-Oxley does not address this potential cause of irregularities.
3. The Herding Story focuses on the incentives of investment fund managers and argues that they are uniquely focused on their quarterly performance vis-a-viz their rivals. As a result, they have an incentive to
Aride the bubble,@ even when they sense danger, because they fear more the mistake of being prematurely prophetic. Again, Sarbanes-Oxley does not address this cause of bubbles and price spikes.This comment compares and contrasts these explanations, finding them highly complementary
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The Ossification of American Labor Law
Cynthia L. Eslund
December, 2002
In this article, Professor Estlund argues that the ineffectuality of American can labor law and the shrinking scope of collective representation and collective bargaining are partly traceable to the law's "ossification" - to its having been essentially sealed off both from democratic revision and renewal and from local experimentation and innovation to a remarkably complete extent and for a remarkably long time. The elements of this process of ossification are various and familiar; yet, once assembled, they make up an impressive set of barriers to innovation. The basic law has been cut off from revision at the national level by Congress; from "market"-driven competition by employers; from the entrepreneurial energies of individual plaintiffs and the plaintiff's bar, and the creativity they can sometimes coax from the courts; from variation at the state or local level by representative or judicial bodies; from the winds of changing constitutional doctrine; and from emerging transnational legal norms. Finally, the National Labor Relations Board - the designated institutional vehicle for adjusting the labor laws to modern conditions - is increasingly hemmed in by the age of the text and the large body of judicial interpretations that has grown up over the years. While the argument may seem to counsel only pessimism about the prospects for reform, it may also help to identify potential pathways of change that have not been fully appreciated. Indeed, some of those pathways are being paved by the process of ossification itself: By impelling private parties to find their own paths outside of the existing regime, the ossification of labor law may be setting in motion the very forces that may eventually lead toward legal change.
This paper forthcoming through Columbia Law Review
www.columbialawreview.org
Enron's Legislative Aftermath: Some Reflections on the Deterrence Aspects of the Sarbanes-Oxley Act of 2002
Michael A. Perino
October 30, 2002
Since Enron’s implosion, an astounding string of accounting scandals have stunned the securities markets. Global Crossing, WorldCom, Adelphia, and a host of other companies have seen plummeting share prices and SEC and criminal investigations. Congress’ reaction has been equally stunning and surprisingly swift. It passed with near unanimity the Sarbanes-Oxley Act of 2002, and President Bush quickly signed it into law. This paper analyzes the new criminal and civil liability provisions of the Act to evaluate whether the Act is likely to achieve its goal of deterring securities fraud. The article concludes that the new criminal liability provisions actually criminalize very little conduct that was not already criminal under existing statutes and do not substantially increase the likelihood of successful conviction. The enhanced criminal penalties are unlikely to create additional deterrence because the Act’s predominant approach is to increase maximum potential sentences. Under the Federal Sentencing Guidelines, such increases have little impact on expected penalties. On the civil side, the article demonstrates that there was no empirical bais for increasing the statute of limitations for private securities fraud causes of action. Finally, the article concludes that the increase in resources and enforcement authority for the SEC may well provide more substantial deterrence than the more publicized criminal provisions of the Act to the extent that these provisions significantly increase the likelihood that securities fraud is detected.
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Did The Private Securities Litigation Reform Act Work?
Michael A. Perino
October 2002
In 1995 Congress passed the Private Securities Litigation Reform Act to address abuses in securities fraud class actions. In the wake of Enron, WorldCom, Adelphia, and other high profile securities frauds, critics suggest that the law made it too easy to escape liability for securities fraud and thus created a climate in which frauds are more likely to occur. Others claim that the Act has largely failed because it did little to deter plaintiff’s lawyers from filing non-meritorious cases. This article employs a database of the 1449 class actions filed from 1996 through 2001 to explore whether the Act achieved several of its primary goals—discouraging the filing of non-meritorious suits, reducing litigation risk for high technology issuers, and reducing the "race to the courthouse" whereby class actions were filed soon after significant stock price declines, apparently with very little pre-filing investigation.
The picture that emerges from studying these data is that the PSLRA did not work as intended. This article demonstrates that as many or more class actions are filed after the Act as before. High technology issuers remain at significantly greater risk than issuers in other industries. There is statistically significant evidence, however, that suggests that the Act improved overall case quality at least in the circuit that most strictly interprets one of the Act’s key provisions, a heightened pleading standard. The data in the article also demonstrate that Congress did not achieve its goal of increasing the filing delay in class actions. Actions are filed as quickly now as they were before passage of the Act. Nonetheless, that too may provide indirect evidence that plaintiff’s attorneys are selecting more apparent cases of fraud that require less pre-filing investigation.
http://www.law.columbia.edu/faculty_mperin/perino_publications.htm
Should the Behavior of Top Management Matter?
Vikramaditya S. Khanna
September 2002
Forthcoming, Georgetown Law Journal, Vol. 91, 2003
Recent events, such as the Enron, Worldcom, and Global Crossing debacles, have brought to the forefront the issue of corporate and organizational wrongdoing and the involvement of top management in it. To date, the law’s response to the knowing or reckless involvement of top management in corporate wrongdoing has been primarily two-fold. First, it increases the sanction imposed on top management. Second, it increases the sanction imposed on the corporation (i.e., the shareholders). This paper examines the second response.
The second response can be examined in multiple ways depending on the analytical perspective being utilized. In this paper I consider the question from three perspectives. First, whether our current law can be justified under a deterrence-based approach to corporate criminal liability. This is the bulk of the paper as that has been where much of the literature in the corporate crime area has developed. Second, whether our current law can be justified under an expressive approach to corporate criminal liability. Third, whether our current law might reflect an attempt to place most of the risk of liability on the corporation, which is generally a better risk bearer than top management. My conclusions are that our current law is difficult to justify under any of these approaches and that it is likely imposing costs on society. This suggests that our current law is in need of reform.
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An American Perspective on the New German Anti-takeover Law
Jeffrey N. Gordon
June 2002
Forthcoming, 12 Die Aktiengesellschaft, December 2002
The new German Takeover Act contains antitakeover provisions that reject the "board neutrality/shareholder choice" of the rejected draft of the 13th Directive. These antitakeover provisions may have a particular (albeit temporary) justification as part of negotiating strategy to obtain a Directive with a "level playing field" approach to a wide variety of control barriers in the EU. This is because assent to cross-border mergers and the transnational economic integration associated with such mergers ultimately depends upon the control of economic nationalism. General vulnerability to takeover bids, in which acquirers who engage in value-reducing home country bias would face a control threat, can play a valuable role in controlling economic nationalism.
Nevertheless, the German antitakeover provisions would have much more adverse impact than the US counterparts to which they are frequently compared. First, the favored US defensive measure, the poison pill, is not available under prevailing German principles of preemptive rights and non-discrimination against any shareholder. German firms are likely to substitute irreversible, value-decreasing measures that were replaced in the US by the pill, such as capital structure changes or asset dispositions. Second, the typical US practice of annual shareholder elections of board members combined with heavy institutional investor ownership in large public firms means that managements are highly sensitive to public shareholder interests in considering a takeover bid. By contrast, German supervisory boards turn over much more slowly, and are co-determined. German management feels less legal and cultural pressure to adhere to public shareholder interests. Third, stock option-laden compensation packages make US managers highly receptive to premium bids, especially because a takeover typically triggers the accelerated vesting of such options. German compensation arrangements do not now and, as a matter of culturally constraint, are unlikely to imitate the US version. So if Germany insists too hard on a 13th Directive to its exact taste, it risks sacrificing internal and cross-border mergers that would produce efficiency gains and aid the EU transnational project.
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Reducing the Tax Costs of Indexed Options
David M. Schizer
July 31, 2002
To encourage pay for performance, Congress offers certain tax advantages when stock options are used as compensation. Yet these advantages arguably are not available to so-called "indexed" options, which reward executives for good relative performance (i.e., instead of absolute increases in stock price). The tax costs of indexed options are as ironic as they are unintended. The relevant tax rules are supposed to favor performance-based pay and, if anything, indexed options are more performance-based than conventional options. As a result, these tax rules should be reformed.
While portions of this Article originally appeared in David M. Schizer, Tax Constraints on Indexed Options, 149 U. PA. L. REV.(2001), this Article is substantially different. Most importantly, this Article explains why some practitioners believe indexed options cannot qualify as performance-based pay under Section 162(m), and thus cannot be deducted in excess of $1 million. This Article offers a legal interpretation that allows a deduction, and suggests that the tax authorities are likely to offer a favorable ruling on this issue.
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Understanding Enron: It's About the Gatekeepers, Stupid
John C. Coffee, Jr.
July 30, 2002
Debacles of historic dimensions tend to produce an excess of explanations. So has it been with Enron, as virtually every commentator has a different diagnosis and a different prescription. Yet, in most respects, Enron is a maddeningly idiosyncratic example of pathological corporate governance, which by itself cannot provide evidence of systematic governance failure. Properly understood, however, the Enron debacle furnishes a paradigm of Agatekeeper failure@ - - that is, of why and when reliance may not be justified on Areputational intermediaries,@ such as auditors, securities analysts, attorneys, and other professionals who pledge their reputational capital to vouch for information that investors cannot easily verify. This comment shows that, during the 1990's, the expected liability costs associated with gatekeeper acquiescence in managerial misbehavior went down, while the expected benefits went up - - with the unsurprising result that earnings restatements and earnings management increased. Diagnosing the circumstances under which Agatekeeper failure@ is likely leads in turn to prescriptions focused on re-aligning the incentives of gatekeepers with those of investors.
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Law's Dominion and the Market for Legal Elites in Japan
Curtis J. Milhaupt and Mark D. WestJune 14, 2002
In this Article, we present data on legal elites in Japan - legally trained university graduates poised to pursue successful careers either as fast-track bureaucrats or lawyers handling sophisticated business transactions. The data show a marked shift in employment patterns over the past decade: increasingly, Japan's most elite university graduates are forsaking the bureaucracy for law.
We find that changes in Japan's underlying economic, political, and legal institutions are a primary cause of this shift. We argue that this trend is not a temporary phenomenon, but reflects a more fundamental transfer of authority in Japan from the bureaucracy to the legal system. The evidence sheds new light on two longstanding debates: the impact of law and lawyers on economic success, and the bureaucracy's role in the governance of the Japanese economy.
The data we examine are hard to square with the widespread view of Japan as "Exhibit A" for the proposition that societies encourage economic growth by steering their most talented youth away from "redistributive legal careers." Rather, the data indicate that in Japan (as elsewhere), talented college graduates pursue positions of power, prestige, and profit. While those positions were once located in the elite economic bureaucracy, they are now migrating to the legal system. Contrary to the evidence of stagnation in the economic and policy environments flowing out of Japan in recent years, close examination of the career choices of Japan's most highly regarded youth reveals a society in transition.
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RACING
TOWARDS THE TOP?:
The Impact of Cross-Listings and Stock Market Competition on International Corporate
Governance
May 30, 2002
During the 1990's, the phenomenon of cross-listing by issuers on international exchanges accelerated, with the consequence in the case of some emerging markets that trading followed, draining the original market of its liquidity. Traditionally, cross-listing has been viewed as an attempt to break down market segmentation and reach trapped pools of liquidity in distant markets. The globalization of financial markets, however, renders this explanation increasingly dated. A superior explanation is Abonding:@ issuers migrate to U.S. exchanges in particular because by voluntarily subjecting themselves to the U.S.'s higher disclosure standards and greater threat of enforcement (both by public and private means), they partially compensate for weak protection of minority investors under their own jurisdiction's law and also credibly signal their intention to make fuller disclosure, thereby achieving a higher market valuation and a lower cost of capital.
Still, many issuers who are eligible to cross-list do not do so. Increasing evidence suggests that cross-listing firms are significantly different from firms in the same jurisdiction that do not cross-list, most notably in that the former have higher growth prospects and are willing to sacrifice some of the private benefits of control to obtain equity finance. Conversely, firms that do not cross-list typically have controlling shareholders who have less interest in stock market valuation because they anticipating selling only in a control transaction at a control premium that they will disproportionately capture. As a result, specialized markets seem likely to persist in order to accommodate both firms that wish to offer superior protections to minority investors and those that prefer to cater to controlling shareholders who want to continue to realize the private benefits of control. Path dependency then may persist.
The latest developments in this new form of regulatory competition have been both (i) the creation of new Ahigh disclosure@ exchanges in emerging markets, and (ii) the enactment of reform legislation intended to protect minority shareholders by jurisdictions that have seen their securities markets lose liquidity to international exchanges. Both efforts seek to share control premia with minority shareholders in order to encourage equity investment. However, such efforts appear to be impeded by the continuing willingness of U.S. exchanges to waive governance listing requirements that are mandatory for their domestic firms in the case of foreign firms.
Finding this new form of regulatory competition to be desirable, this article argues that its distinguishing characteristic is that it is Aexit-less@(and thus differs from the Aissuer choice@ model of regulatory competition), and it recommends that the current broad exemption under which U.S. exchanges waive all governance listing requirements for foreign issuers should be reconsidered.
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Incomplete
Law - A Conceptual and Analytical Framework
- And its Application to the Envolution of Financial Market Regulation -
April 2002
This paper develops a conceptual framework for the analysis of legal institutions. It argues that law is inherently incomplete and that the incompleteness of law has a profound impact on the design of lawmaking and law enforcement institutions. When law is incomplete, residual lawmaking powers must be allocated; and enforcement agents have to be vested with law enforcement powers. The optimal allocation of lawmaking and law enforcement powers under incomplete law is analyzed with a focus on the legislature, regulators and courts as possible lawmakers, and courts as well as regulators as possible law enforcers. The timing and process of lawmaking and law enforcement differs across these agents. Legislatures are ex ante, courts are ex post lawmakers, regulators have combine ex ante and ex post lawmaking functions. Courts are reactive law enforcers, while regulators are proactive law enforcers in that – unlike courts - they can initiate enforcement procedures. We argue that the optimal allocation of residual lawmaking and law enforcement powers is determined by the degree and nature of incompleteness of law, the ability to standardize actions that may result in harm, and the magnitude of harm and externalities expected from such actions. Under highly incomplete law, regulators are superior to courts when actions can be standardized and, if allowed to proceed, may create substantial externalities. Otherwise courts are optimal holders of lawmaking and law enforcement powers. We apply this analytical framework to the development of financial market regulation in England since the mid 19th century, with comparative reference to developments in the United States and Germany. The comparative evidence suggests that financial market regulators with both residual lawmaking and proactive law enforcement powers emerged in all three jurisdictions in response to ineffective judicial law enforcement of highly incomplete law.
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What Enron Means for the Management
and Control of the Modern Business Corporation:
Some Initial Reflections
Jeffrey N. Gordon
Forthcoming, University of Chicago Law Review, Summer, 2002
The Enron case challenges some of the core beliefs and practices that have underpinned various positions in the debates about corporate law and governance, including mergers and acquisitions, since the 1980s. In particular, Enron raises at least the following problems for the received model of corporate governance:First, it provides another set of reasons to question the strength of the efficient market hypothesis, here, the company’s dizzyingly high stock price despite transparently irrational reliance on its auditors’ compromised certification.
Second, it undermines faith in the corporate governance mechanism – the monitoring board – that has been offered as a substitute for unfettered shareholder access to the market for corporate control. In particular, the board’s capacity to protect the integrity of financial disclosure has not kept pace with the increasing reliance on stock price performance in measuring and rewarding managerial performance.
Third, it suggests the existence of tradeoffs in the use of stock options in executive compensation because of the potential pathologies of the risk-preferring management team.
Fourth, it shows the poor fit between stock-based employee compensation and employee retirement planning. More generally, it raises questions about the shift in retirement planning towards defined contribution plans, which make employees risk bearers and financial planners, and away from defined benefit plans, which impose some of the risk and fiduciary planning obligations on firms.
Although the disclosure, monitoring and other failures may lead to useful reforms, Enron also reminds us that there is a problem that cannot be solved but can only be contained in the tension between imperfectly fashioned incentives and self-restraint.
Keywords: Enron, corporate governance, efficient market, accountants, directors, stock options, pensions
JEL classifications G14, G34, K22, L14, M52
Download this paper in Acrobat formatForthcoming Columbia Business Law Review, Spring, 2002
In this Essay, Victor Fleischer describes the "gap" between what is taught in law schools and what is needed in corporate transactional practice. The Essay identifies three related reasons why schools have struggled to teach transactions effectively: (1) the lack of a conceptual framework, (2) the lack of qualified teachers, and (3) the lack of quality teaching materials. The Essay then describes how the Deals program at Columbia Law School addresses these problems and provides students with a pedagogically sound and effective introduction to corporate transactional practice
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The Rise and Fall of Article 2
Robert E. Scott
Forthcoming Louisiana Law Review, Vol. 63, 2002
On August 13, 2001 the National Conference of Commissioners on Uniform State Laws voted 89 to 53 to reject the 2001 Amendments to Article 2 of the Uniform Commercial Code that had just been approved in May by the American Law Institute. While negotiations continue, this public split between the two bodies that have together shepherded the UCC project for over fifty years represents the likely end of the fourteen year effort to revise the law of sales as embodied in Article 2.
In this Essay, I examine the political economy of the Article 2 project from its origins to the present. I begin by analyzing the drafting and enactment process of the original Article 2 and evaluate the success of the new sales law it introduced, a success attributable in no small measure to the replacement of archaic vestiges of property law with efficient contract default rules. I then I consider the effects of the compromises Karl Llewellyn made to secure the enactment of the Code. Of particular significance is how the vague terms that invoke the commercial context (originally intended by Llewellyn as a means of incorporating ex ante default rules) have been used to challenge the objective meaning of disputed contracts. For many commercial contractors, exit may have been a cheaper option than lobbying for clearer and more predictable default rules. But the parties to mass-market sales transactions remain subject to Article 2, and their representatives have sought to influence the revision process. Thus, the focus has shifted from Llewellyn's original goal of prescribing optimal default rules for commercial contracts to the current debate over proscribing freedom of contract in mass-market transactions. The resulting divergence between the interests of producers and those of consumer buyers, computer information licensees and their representatives has produced deadlock.
I conclude that the flaws in the Article 2 project were present from its inception. Given the limits of legal regulation, it is unlikely that any set of "uniform" rules that are promulgated for adoption in every state can both efficiently complete the gaps in commercial contracts as well as optimally police consumer transactions. In sum, the uniform laws process works when there is distributional symmetry (when today's buyer might be tomorrow's seller). On the other hand, the process deadlocks when it seeks to produce uniform rules for transaction-types in which the distributional effects are asymmetric and prices do not adjust efficiently to compensate for the victory of one group in the legislative process.
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Enron's Dirty Little Secret: Waiting for the Other Shoe to Drop
Victor Fleischer
Tax Notes, Vol. 94, No. 8, February 2002
How is it that Enron, allegedly the seventh-largest company in the U.S., didn't pay any income tax for four out of the last five years? In this short commentary piece, I argue that the tax Code got it right and the accountants got it wrong. Using the MIPS transaction (a debt/equity hybrid) and an off-balance sheet partnership as examples, I argue that in Enron's case, the tax Code did a better job of measuring income than the accountants. The reason Enron didn't pay any income tax is because it didn't have any real income. On a more cautionary note, however, the article suggests that the tax bar must move quickly towards effective self-regulation if it wants to avoid the current problems facing the accounting industry.
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Understanding Venture Capital Structure: A Tax Explanation for Convertible Preferred Stock
Ronald J. Gilson and David M. Schizer
February 2002
The capital structures of venture capital-backed U.S. companies share a remarkable commonality: overwhelmingly, venture capitalists make their investments through convertible preferred stock. Not surprisingly, a large part of the academic literature on venture capital has sought to explain this peculiar pattern. Financial economists have developed models showing, for example, that convertible securities allocate control depending on the portfolio company's success, operate as a signal to overcome various kinds of information asymmetry, and align the incentives of entrepreneurs and venture capital investors. In this Article we extend this literature by examining the influence of a more mundane factor, tax law, on venture capital structure. A firm that issues convertible preferred stock to venture capitalists is able to offer more favorable tax treatment for incentive compensation paid to the entrepreneur and other portfolio company employees: Instead of being taxed currently at ordinary income rates, the entrepreneur and employees can defer tax until the incentive compensation is sold (or even longer), at which point a preferential tax rate is available.
No tax rule explicitly connects the employee's tax treatment with the issuance of convertible preferred stock to venture capitalists. Rather, this link is part of tax "practice" - the plumbing of tax law, familiar to practitioners but, predictably, opaque to those, including financial economists, outside the day-to-day tax practice. Despite its obscurity, this tax factor is likely to be of first order importance. Intense incentive compensation for portfolio company founders and employees is a fundamental feature of venture capital contracting. Favorable tax treatment for this compensation is a by-product and, we believe, a core purpose of the use of convertible preferred stock.
We also highlight an important but low visibility tax subsidy for the venture capital market, and the early stage, usually high technology, firms that are financed there. Although this subsidy arose inadvertently, it has an interesting structure. Funds are not provided directly to companies selected by the government (a familiar technique outside the United States), or to all companies. Instead, venture capital investors are enlisted as the subsidy's gatekeeper. As a practical matter, only companies that can attract venture capital investment receive this subsidy. Our analysis thus adds a different twist on the familiar debate about providing subsidies through the tax system, instead of through direct expenditures or favorable regulatory treatment.
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Free Riding on Hot Wheels
Victor P. Goldberg
October 2002
Forthcoming, Winter 2002 issue of Antitrust Bulletin
When warehouse clubs started making inroads into its market, Toys R Us responded with a policy designed to limit the clubs’ access to certain toys. The FTC successfully challenged the policy, arguing that TRU had coordinated a horizontal agreement amongst the toy manufacturers to eliminate competition from this new class of competitors.
[1] TRU defended itself, invoking the free-rider rationale. This the Commission rejected as pretext. TRU’s argument was better than the Commission gave it credit for, but it failed to press its best argument. That failure stems in part from the shortcomings of the standard free rider formulation, and in part from the defendant’s need to tailor its arguments to ill-fitting doctrinal constraints. TRU attempted to convince the Commission that its actions were unilateral, within the Colgate exception.[2] Perhaps they were, although the Commission found to the contrary. Regardless, the net result was suppression of an efficiency rationale that emphasized the benefits of cooperation by the toy manufacturers.In this paper, I will argue that TRU emphasized the wrong free rider problem. Properly framed, the behavior of TRU and the toy companies can be seen as consistent with the efficiency goals of antitrust policy. That a plausible efficiency argument can be constructed does not mean that the outcome itself was wrong. My narrow focus here is on showing that the standard formulation led to asking the wrong question.
Part I provides a brief overview of the market and TRU’s behavior. Part II summarizes the defense’s rationale and the Commission’s rejection of it. Part III provides an alternative explanation. Part IV concludes.
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Lipton and Rowe's Apologia for Delaware: A Short Reply
Ronald J. Gilson
December 2001
In Unocal Fifteen Years Later I offered a respectful but negative assessment of the Delaware Supreme Court's post- Unocal efforts to walk a line between managerialists who believe directors should be able to block a hostile takeover, and those who believe the ultimate decision whether to accept a takeover bid belongs to the shareholders. I suggested that Delaware law could be repositioned without requiring the Delaware Supreme Court to confess error by allowing shareholder adopted bylaws that repeal or amend poison pills. Martin Lipton and Paul Rowe responded to my essay by arguing that recent economic challenges to efficient market theory, together with studies showing that the poison pill leads to increased takeover premia, undermines the premise on which a shareholder choice regime is based. In this reply, I correct Lipton and Rowe's misunderstanding of the role of market efficiency (and recent critical studies) in assessing shareholders' role in the governance of takeovers, as well as their assessment of why a poison pill may increase takeover premia.
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The Content of Our Casebooks: Why Do Cases Get Litigated
Samuel Issacharoff
January 2002
Forthcoming in Florida State Law Review, Vol. 29, No. 4This is the 2000 Mason Ladd Lecture delivered at Florida State. It is intended primarily for law students as a guide to the different approaches to the question of why cases actually litigate. The article begins with the premise that in any dispute the only mechanism for reducing the joint welfare of the parties is to engage agents to litigate the distribution of the contested assets. Beginning with that premise, the Article traces the various explanations given for why cases do actually proceed to litigation. The first part of the article is a rendition of the classic account from the economic analysis of law. The second, and longer, part of the Article then turns to various behavioral insights that call into question some of the simpler assumptions of the standard law and economics account of litigation. The paper includes data drawn from posing classic framing questions to the first-year body at FSU to highlight some of the behavioral considerations in litigation.
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Economic Development, Legality, and the Transplant Effect
Daniel Berkowitz, Katharina Pistor & Jean-Francois Richard
September 2001
Forthcoming in European Economic Review
We analyze the determinants of effective legal institutions (legality) using data from forty-nine countries. We show that the way the law was initially transplanted and received is a more important determinant than the supply of law from a particular legal family. Countries that have developed legal orders internally, adapted the transplanted law, and/or had a population that was already familiar with basic principles of the transplanted law have more effective legality than countries that received foreign law without any similar pre-dispositions. The transplanting process has a strong indirect effect on economic development via its impact on legality, while the impact of particular legal families is weaker and not robust to alternative legality measures.
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On the (Fleeting) Existence of the Main Bank System and Other Japanese Economic Institutions
Curtis J. Milhaupt
November 9, 2001
In an accompanying essay to be published in the same journal, Professors Miwa and Ramseyer (M&R) argue that most of the comparative corporate governance academy interested in Japan has been chasing a myth. The myth, which M&R largely attribute to economist Masahiko Aoki’s influential theories tying Japanese production to a system of delegated bank and governmental monitoring, is the existence of the "main bank system" and the related institutions of lifetime employment and keiretsu groups.
In this essay, I critique M&R’s revisionist thesis. After a brief survey of formative events in the creation of the "conventional wisdom" about Japanese corporate governance, I present data and analysis that call into question the significance of the evidence relied upon by M&R to substantiate their claims. Next, I sketch a legal and norm-based analysis of postwar corporate governance that complements Aoki’s economic perspective. I conclude that while M&R provocatively challenge several stylized facts, they do not ultimately cast great doubt on the power of Aoki’s theoretical construct or the (past) existence of Japan’s institutional setting for corporate governance. Interested observers can rest at ease: these economic institutions did exist. Attention can now turn to a more pressing issue: how best to replace them.
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Institutional Change and M & A in Japan: Diversity Through Deals
Curtis J. Milhaupt & Mark D. West
November 5, 2001
This Article offers new perspectives on the market for corporate control, the convergence debate, and Japanese corporate governance. We begin by applying in the corporate governance setting two related insights from other fields: from economics, the theory that there is no universally efficient organizational model; from organizational behavior, evidence that diverse groups outperform homogeneous ones. We then consider the potential for convergence toward a particular governance technology—the market for corporate control—to increase the desirable trait of diversity within economic systems. Takeovers, we argue, are not exclusively a disciplinary device, but also an engine of managerial and legal innovation.
We apply these insights to Japan through a detailed examination of previously unexplored data on Japanese M&A. We first link the historically low level of Japanese M&A activity to a thick institutional environment much more complex than the conventional focus on cross-shareholding suggests. Among the more startling findings is the existence of negative control premiums in Japanese tender offers and the role of legal shareholder protections in dampening the market for corporate control. Next, we show how the dearth of takeovers is inextricably linked to the lack of diversity in Japanese corporate practices. We then explore how recent changes in "institutions for deals" in Japan correlate with increased takeover activity, which in turn is linked to the creation of a broader range of governance practices, managerial innovations, and structural shifts in corporate lawmaking processes. The Article concludes by analyzing the implications of our findings for two academic debates: the role of functional substitutes in comparative corporate governance theory, and the impact of legal investor protections on corporate governance patterns.
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Competition Among Securities Markets: A Path Dependent Perspective
John C. Coffee, Jr.
April 1, 2002
Today, there are an estimated 150 securities exchanges trading stocks around the world. Tomorrow (or at least within the reasonably foreseeable future), this number is likely to shrink radically. The two great forces reshaping the contemporary world - globalization and technology - impact the world of securities markets in a similar and mutually reinforcing fashion:
(1) they force local and regional markets into more direct competition with distant international markets;
(2) they increase overall market capitalization and lower the cost of equity capital, as issuers are enabled to access multiple markets; and
(3) they permit order flow and liquidity to migrate quickly from local markets to international "super-markets," sometimes with adverse consequences for smaller domestic markets.
In overview, these consequences follow because globalization has lowered the barriers to cross-border capital flows, including in particular traditional restrictions on foreign investments in domestic stocks, while technology has made instantaneous information flows feasible, thereby enabling electronic securities markets to link dealers and markets participants around the world in continuous world-wide trading.
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The Acquiescent Gatekeeper:
Reputational Intermediaries, Auditor Independence and the Governance of Accounting
John C. Coffee, Jr.
The role of "gatekeepers" as reputational intermediaries who can be more easily deterred than the principals they serve has been developed in theory, but less often examined in practice. Initially, this article seeks to define the conditions under which gatekeeper liability is likely to work - - and, correspondingly, the conditions under which it is more likely to fail. Then, after reviewing the recent empirical literature on earnings management, it concludes that the independent auditor does not today satisfy the conditions under which gatekeeper liability should produce high law compliance. A variety of explanations - - poor observability, implicit collusion, and high agency costs within the gatekeeper - - provide overlapping explanations for gatekeeper failure. What remedy should work best to minimize such failures? As a more appropriate and supplementary remedy to reliance on class action litigation, this article recommends fundamental reform of the governance of the accounting profession. In particular, it contrasts the structure of self-regulation within the broker-dealer industry with the absence of similar self-discipline in the accounting profession. While such reform may be unlikely, its absence strongly implies that earnings management is likely to remain a pervasive phenomenon. Download this paper in Acrobat formatForthcoming in Pennsylvania Law Review, Vol. 149, Issue No. 6, 2001
This paper analyzes the origins, persistence, and current evolution of a series of non-legal rules (or "norms") that have played an important role in Japanese corporate governance. The four central features of the governance environment examined here include: 1) the main bank system, in which banks voluntarily restructure loans to some distressed borrowers, 2) a social distaste for hostile takeovers, 3) implicit promises of employment stability, and 4) belief systems about the proper role and structure of the board of directors. I show that, despite virtually ubiquitous claims to the contrary, these norms do not enjoy a long history of practice in Japan, but rather emerged only in the immediate postwar period. I hypothesize that they emerged for two reasons: First, they served as a low-cost substitute for a troubled formal institutional environment beset by the "transplant effect" that imperils legal reform in transition economies today. Second, they provided private benefits to the small number of interest groups that emerged intact from World War II. The flow of private benefits to norm adherents explains the persistence of the norms despite clear evidence of their inefficiency over the past decade.
I demonstrate that current models of norm reform, which emphasize the role of exogenous shocks, the workings of norm entrepreneurs, and increased information, explain why the norms of Japanese corporate governance are currently evolving.
Finally, extrapolating from Japan’s experience, I suggest how norm analysis can contribute to the two most pressing questions in comparative corporate governance today: whether law matters to corporate governance, and whether diverse systems of corporate governance are converging toward the Anglo-American model. As to both questions, I suggest that closer attention to norms reveals shortcomings in the existing literature.
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Publication Rules in the Rulemaking Spectrum: Assuring Proper Respect for an Essential Element
Peter L. Strauss
March 7, 2001
The American rulemaking spectrum ranges from one Constitution, through hundreds of congressional statutes, thousands of administrative regulations, and tens of thousands of important guidance documents to innumerable more casual agency documents such as press releases or letters of advice. Our legal system treats constitutions, statutes and regulations, if valid, as binding text, subject only to the requirements that they be authorized by the superior authority and appropriately adopted following designated procedures; if valid, each of them has legislative effect on government and citizen alike, until displaced by another text validly adopted at the same or a higher level. The innumerable casual items at the base of this pyramid, while often in fact influential on private conduct, are denied any formal jural effect. It is at the level of important guidance documents that one finds confusion; confusion whether they are legitimate instruments of agency policy or a ruse to evade the higher procedural obligations associated with adopting regulations; confusion whether an agency may give them any jural effect and, if so, to what degree; and confusion whether and to what extent they must be respected by the courts. Since the frequency with which these documents are prepared suggests their importance, this confusion is regrettable.
Generally ignored provisions of the American Administrative Procedure Act, 5 U.S.C. 552(a)(1,2), appear to recognize that these documents may be treated as if they were precedents (not legislative documents) if they have been appropriately published. Hence, they may be described as "publication rules," to distinguish them from the more formal regulations that are adopted following notice and comment procedures and that enjoy, if valid, legislative effect. The paper builds on these provisions to critique recent judicial decisions and to suggest a general approach to publication rules following the model of precedent.
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Tax Constraints on Indexed Options
David M. Schizer
February, 2001
Indexed stock option grants reward executives for outperforming a benchmark, such as the market as a whole or competitors in the same industry. These options offer superior incentives by diminishing the influence of factors beyond an executive's control, such as general market and industry conditions. Yet indexed options are almost never used. Professor Levmore seeks to explain this puzzle with norms. The main point of this comment on his Article is that tax plays a larger role in this puzzle than Professor Levmore acknowledges, although tax is not a complete explanation. The tax appeal of traditional options is that they offer value that is not really performance-based (i.e., a bet on the market as a whole), but nevertheless is treated as Aperformance based@ under Section 162(m) -- and thus is deductible without limitation. Accounting and Professor Levmore's norms-based account are then briefly considered.
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Frictions as a Constraint on Tax Planning
David M. Schizer
February, 2001
In recent years, the government has enacted a series of narrow tax reforms targeting specific planning strategies. Sometimes these reforms stop the targeted planning, but sometimes they merely prompt a new, more wasteful variation. The difference often lies in so-called frictions, which are constraints on tax planning other than the tax law, such as fees, accounting or regulatory treatment, credit risk, and the like. While frictions are important, reformers often lack key information, and legal academics should help provide it. This Article offers general observations about frictions that deter end runs. Most promising are strong "discontinuous" frictions that impose significant costs when taxpayers depart, even in subtle ways, from the transaction covered by the reform. Costs of relying on frictions are also considered, including information costs and distributional effects. Two case studies also are offered involving tax-motivated use of derivative financial securities. These reforms use essentially the same statutory language, but taxpayers have responded differently – and frictions explain this difference. The first reform, the "constructive sale" rule of Section 1259, targets use of derivatives in effect to sell an appreciated asset without paying tax. The second, the "constructive ownership" rule of Section 1260, targets use of derivatives in effect to invest in a hedge fund (or other pass-through entity) without the usual adverse tax consequences (i.e., less deferral and a higher tax rate). Theoretically, taxpayers can avoid either rule through relatively modest changes in the derivative’s economic return. This strategy is commonly used to avoid Section 1259, a reality that was understood by government and taxpayers alike when the measure was enacted. In contrast, this strategy is not commonly used to avoid Section 1260. The difference, which was not well understood by Section 1260’s drafters, is that securities dealers cannot supply the derivative that theoretically avoids the rule.
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Mark Roe
January 16, 2002
A strong theory has emerged in recent years that the quality of corporate law determines whether securities markets will arise, whether ownership will separate from control, and whether the modern corporation will prosper. The theory has been used convincingly to explain why we see weak corporate structures in transition and developing nations, less convincingly to explain why concentrated ownership persists in continental Europe, and probably incorrectly to explain why ownership separated from control in the United States. Surely, when an economically-weak society lacks regularity?a gap that may be manifested by weak or poorly enforced corporate law?that lack of regularity and that lack of economic strength precludes complex institutions like securities markets and diffusely-owned public firms. But in several nations in the wealthy west legal structures are quite good and, by measurement, shareholders are well-protected, but ownership has still not yet separated from control. Something else has impeded separation. We can hypothesize what that something is by examining the calculus of owners and investors when the decision is being made as to whether to diffuse ownership. Ownership cannot readily separate from control when managerial agency costs are especially high. And missing from current theory, empirical work, and discourse is the basic concept that even American corporate law? usually seen as high quality nowadays? does not burrow into the firm to root out those managerial agency costs that arise from mediocre business decisions. Judicial doctrine and legal inquiry attack self-dealing, not bad business judgment. The business judgment rule, under which judges do not second-guess managerial mistake, puts the full panoply of agency costs?such as over-expansion, over-investment, and reluctance to take on profitable but job-threatening risks?beyond any direct legal inquiry. (This limit from the business judgment rule is not a "defect" in corporate law: aggressive judicial attack on managerial error would replicate the costs of government management of business. Something other than direct legal attack has to control basic managerial agency costs, because judicial action here is far too costly.) The consequence is that even if corporate law as usually conceived is "perfect," it eliminates self-dealing, not managerial mistake. But managers can lose for shareholders as much, or more, than they can steal from them, and law controls only the second cost not the first. If the risk of managerial error varies widely from nation-to-nation, or from firm-to-firm, ownership structure should vary equally widely, even if conventional corporate law tightly protects shareholders. There is also good reason, and data, consistent with this analysis: by measurement several nations have fine enough corporate law; distant stockholders are well-protected from controlling stockholder and managerial thievery, but ownership in those nations still has not separated from control. As it happens, legally uncontrolled agency costs though seem to be especially high in those very nations. Download this paper in Acrobat formatProduct markets are weaker in some nations than they are in others.. Weaker product markets have more monopolies and more monopoly profits, both of which affect politics and corporate governance structures. They affect corporate governance structures directly by increasing managerial agency costs to shareholders, which shareholders then seek to reduce. One would expect corporate governance structures, laws, and practices to differ in nations with monopoly-induced high agency costs from those prevailing in nations with more competition, fewer monopolies, and lower agency costs. The monopoly profits also affect corporate governance structures indirectly by setting up a fertile field for conflict inside the firm as the corporate players—shareholders, managers, and employees—seek to grab those monopoly profits for themselves. And we might speculate that these rents when large enough affect democratic politics and law-making: directly by making monopolists political targets (and political forces); and indirectly as the players inside the firm seek to capture those monopoly profits through political action, with political parties and ideologies (and, in time, laws and standards) that parallel the players’ places inside the firm. Data from the industrial organization, finance economics, and political science literature is consistent.
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Recent empirical work has found that the private benefits of control differ significantly depending upon the underlying legal system in which the firm is incorporated. In particular, common law systems appear to outperform French civil law systems, but are trumped in turn by Scandinavian civil law systems. This evidence could be read to support the "law matters" thesis first advanced by Professors LaPorta, Lopez-de-Silanes, Shleifer and Vishny, which finds that "common law" legal systems incorporate superior legal protections for minority shareholders and therefore have deeper capital markets and more dispersed ownership. But the apparent superiority of Scandinavian legal systems complicates, and possibly subverts, this analysis, both because Scandinavian legal systems are more "like" other civil legal systems than they are "like" common law legal systems and because Scandinavian law does not encourage private enforcement of law through class actions and similar devices. Hence, an alternative hypothesis suggests itself: social norms in Scandinavia may discourage predatory behavior by those in control of the firm. This paper explores the competing merits of these two rival hypothesis - - law versus norms as instruments of social control - - by comparing the private benefits of control in various countries to other benchmarks, such as rates of criminal victimization. Although it finds no universal pattern, some strong congruences are discernible within particular legal systems (i.e., Scandinavian crime rates are very low, as are the private benefits of control that controlling shareholders expropriate from Scandinavian firms). A revised hypothesis is thus suggested: crime rates and the private benefits of control are the lowest in countries having the highest level of social cohesion and the lowest level of recent social and political disruption. This explanation works well for countries with crime and high private benefits of control (e.g., Russia, Mexico, and Brazil), but less well for many common law countries (such as the U.S.) in which the private benefits are low, but crime is high.
One implication of this comparison is that the impact of norms may be greatest when law is the weakest. This possibility may explain best why behavior within Scandinavian firms is different from that in French civil law firms, when both share relatively weak legal rights.
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Deep and liquid securities markets appear to be an exception to a worldwide pattern in which concentrated ownership dominates dispersed ownership. Recent commentary has argued that a dispersed shareholder base is unlikely to develop in civil law countries and transitional economies for a variety of reasons, including (1) the absence of adequate legal protections for minority shareholders, (2) the inability of dispersed shareholders to hold control or pay an equivalent control premium to that which a prospective controlling shareholder will pay, and (3) the political vulnerability of dispersed shareholder ownership in left-leaning "social democracies." Nonetheless, this article finds that significant movement in the direction of dispersed ownership has occurred and is accelerating across Europe.
But can this trend persist in the absence of strong legal protections for minority shareholders and in the presence of high private benefits of control? To understand how dispersed ownership might both arise and persist in the absence of the supposed legal and political preconditions, this article reconsiders the appearance of dispersed ownership in the late 19th and early 20th Centuries in the U.S. and the U.K. and contrasts their experience with those of France and Germany over the same period. During this era, the private benefits of control were high, and minority legal protections in the U.S. were notoriously lacking, as the famous Robber Barons of the age bribed judges and legislators and effectively employed regulatory arbitrage to escape even minimal anti-fraud regulation. Nonetheless, strong self-regulatory institutions (most notably, the New York Stock Exchange) and private bonding mechanisms by which leading underwriters pledged their reputational capital by placing directors on the board of sponsored firms enabled the equity market to expand and dispersed ownership to arise. In contrast, in the U.K., the London Stock Exchange for a variety of path-dependent reasons played a far more passive role and did not become an effective self-regulator until much later in the 20th Century. Yet, dispersed ownership also arose, although at a slower pace. The lesser role for private self-regulation in the U.K. may have been the consequence of its lesser need for self-regulation as a functional substitute for formal law, given both earlier legislation in the U.K. and lesser exposure to judicial corruption and regulatory arbitrage.
In contrast to the New York and London Exchanges, the Paris Bourse over this same period made little, if any, effort to develop a self-regulatory structure or to upgrade listing or disclosure standards. Why not? The answer seems closely associated with the fact that it operated as a state-administered monopoly whose stockbrokers were formally considered civil servants and who were legally denied the ability to trade as principals for their own account. Facing no competition and composed of members having little incentive to promote or enhance its reputational capital, the Paris Bourse did not innovate and fell behind the London Stock Exchange. The intrusive role of state regulation, which discouraged private self-regulatory initiatives, appears to have a factor in its competitive decline. In Germany, the state strongly supported the growth of large private banks but imposed a high stamp tax on securities transactions that quickly chilled the then growing securities market. In addition, because the German central bank offered very liberal rediscounting terms to the principal private banks, German banks were in effect subsidized in their role as providers of capital to German heavy industry, while the securities market was correspondingly denied the ability to extend credit by punitive legislation enacted in 1896. In this respect, concentrated ownership seems less to have evolved naturally than to have been subsidized by the state.
What then are the preconditions for the separation of ownership and control? The U.S. and European experiences in the late 19th Century suggest that the first step is the separation of the market from politics. When, as in late 19th Century France, the government administers the market, the market suffers. Although proponents of the "law matters" hypothesis argue that liquid securities markets cannot develop in the absence of a legal system that protects shareholder rights, the U.S. and U.K. experience are to the contrary and suggest that functional substitutes for close governmental regulation can be developed. This conclusion does not require rejection of the "law matters" hypothesis, because the principal historic advantage that common legal systems gave the embryonic securities markets of the late 19th Century was a decentralized state, in which self-regulation was the norm and close state control the exception. In contrast, in civil law systems of the same era, the state monopolized all law-making initiatives.
The critical achievement of self-regulation in the United States was the development of mechanisms by which control could be held in the public market, rather than simply in the hands of controlling shareholders. During the late 19th Century, this meant protection from predatory raiders who sought to assemble controlling blocks without paying a control premium. In both the U.S. and the U.K., these protections were first developed through private (or semi-private) ordering and then formalized in legislation. For the future, private ordering may similarly be able to close much of the gap between "advanced" Western legal systems and those of transitional economies, even in the absence of desirable reforms in mandatory law. By no means does this article argue that state regulation of securities markets is undesirable or unnecessary. Market manipulations have characterized all unregulated securities markets and have ultimately elicited regulation. Its more modest claims are that (i) intelligent self regulation by securities exchanges and professional associations in transitional economies can close much of the gap between "advanced" Western markets and those of transitional economies, and (ii) the first necessary step towards dispersed ownership is to enable control to be held in the market by legal rules and/or private ordering mechanisms that protect the public shareholder from stealth acquisitions of control.
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Forthcoming in Revue Internationale du Droit d'Auteur, January 2001
A dispute resolution panel of the World Trade Organization in June 2000 held the United States in contravention of its obligation under art. 13 of the TRIPs accord to Aconfine limitations or exceptions to exclusive rights to certain special cases which do not conflict with a normal exploitation of the work and do not unreasonably prejudice the legitimate interests of the right holder.@ In the dispute resolution proceeding, initiated by the European Union at the behest of the Irish performing rights organization, the contested exception, enacted in the 1998 ADigital Millennium Copyright Act,@ exempted a broad range of retail and restaurant establishments from liability for the public performance of musical works by means of communication of radio and television transmissions.
The WTO panel decision marks the first time an international adjudicative body has interpreted either art. 13 of TRIPs, or art. 9.2 of the Berne Convention, the text TRIPs incorporates, and generalizes from the Berne Convention reproduction right to all TRIPs and Berne rights under copyright. Berne art. 9.2/TRIPs art. 13 impose the Athree-step test@ to evaluate the legitimacy of exceptions and limitations on copyright; the panel's decision extensively analyzes each of the steps. As other multilateral instruments, such as the 1996 WIPO Copyright Treaty (art. 10) and WIPO Performers and Phonograms Treaty (art. 16.2), as well as the pending European Union Information Society Directive (art. 5.4), increasingly adopt the Athree-step test,@ the WTO Panel decision may significantly advance the development of a truly supra national law of copyright.
This article will analyze the Panel's interpretation of the test's three steps, and their application to the U.S.-law exemption. The article will also compare the Panel's treatment of the three-step test with the prior analyses proposed by several Berne Convention commentators, in order to reflect on what the Panel's analysis might mean for copyright exceptions more broadly. It is important to recognize, however, that the decision's actual impact on international copyright law will also depend on other considerations that will not be addressed here, including: Member State compliance with Panel decisions; the precedential effect of one Panel decision on later dispute resolution panels; and the willingness of national courts to look to WTO Panel decisions for guidance in evaluating local exceptions.
Download this paper in Acrobat formatSales and Elections as Methods for Transferring Corporate Control
Ronald J. Gilson & Alan Schwartz December, 2000 Under standard accounts of corporate governance, capital markets play a significant role in monitoring management performance and, where appropriate, replacing management whose performance does not measure up. Recent case law in Delaware, however, appears to have altered dramatically the mechanisms through which the market for corporate control must operate. In particular, the interaction of the poison pill and the Delaware Supreme Court's development of the legal standard governing defensive tactics in response to tender offers have resulted in a decided, but as yet unexplained, preference for control changes mediated by means of an election rather than by a market. In this paper, we begin the evaluation of the preference for elections over markets that the Delaware Supreme Court has not yet attempted. We apply to this effort both doctrinal logic and insights derived from an interesting but complex formal literature that has developed to understand how voting structures work in political contests and jury deliberations. Since these contexts differ substantially from transfers of corporate control, our analysis raises a question of fit: are voting models suitable for analyzing the question asked here; In our view, the models do shed some light on the takeover institution, but if this view is ultimately rejected, then we will have eliminated what at least superficially appears to be a useful set of tools.Download this paper in Acrobat
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CONVERGENCE AND ITS CRITICS:
What Are The Preconditions to the Separation of Ownership and Control?
John C. Coffee, Jr
September 12, 2000
Forthcomingin Convergence and Diversity in Corporate Governance Regimes and Capital Markets,
being published by Oxford University Press
Recent commentary has argued that deep and liquid securities markets and a dispersed shareholder base are unlikely to develop in civil law countries and transitional economies for a variety of reasons, including (1) the absence of adequate legal protections for minority shareholder, (2) the inability of dispersed shareholders to hold control or pay an equivalent control premium to that which a prospective controlling shareholder will pay and (3) the political vulnerability of dispersed shareholder ownership in left-leaning "social democracies." Nonetheless, this article finds that significant movement in the direction of dispersed ownership has occurred and is accelerating across Europe.
To understand how dispersed ownership can arise in the absence of the supposed legal and political preconditions, this article reconsiders the appearance of dispersed ownership in the late 19th and early 20th Century in the U.S. and the U.K. During this era, the private benefits of control were high, and minority legal protections in the U.S. were notoriously lacking, as the famous Robber Barron of the age bribed judges and legislators and effectively employed regulatory arbitrage to escape regulation. Nonetheless, strong self-regulatory institutions (most notably, the New York Stock Exchange) and private bonding mechanisms by which leading underwriters pledged their reputational capital by placing directors on the board of sponsored firms enabled the equity market to expand and dispersed ownership to arise. In contrast, in the U.K., the London Stock Exchange for a variety of path-dependent reasons played a far more passive role and did not become an effective self-regulator until much later in the 20th Century. Yet, dispersed ownership also arose, although at a slower pace. The lesser role for private self-regulation in the U.K. may have been the consequence of its lesser need for self-regulation as a functional substitute for formal law, given both earlier legislation in the U.K. and lesser exposure to judicial corruption and regulatory arbitrage.
Based on these examples, this article argues that "functional convergence" will dominate "formal convergence" and that the principal mechanism of functional convergence may be private self-regulation. However, rather than reject the "law matters" hypothesis, this article suggests that one of the principal advantages of common law legal systems is their decentralized character, which encourages self-regulatory initiatives, whereas civil law systems may monopolize all law-making initiatives. Further, this article proposes that legal reforms, while important, are likely to follow, rather than precede, market changes -- as happened in both the U.S. and the U.K. Once however a constituency for liquid and transparent securities market is thus created, it will predictably seek and secure legislation that fills in the enforcement gap that self-regulation leaves. Both in the U.S., the U.K. and Europe today, the growth of securities markets has been largely divorced from politics.
What then are the preconditions for the separation of ownership and control? The key answer is that public shareholders be able to retain control, protected from the threat of stealth raiders who can assemble controlling blocks without paying a control premium. In both the U.S. and the U.K., these protections were first developed through private (or semi-private) ordering and then formalized in legislation.
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Copyright Use and Excuse on the Internet
Jane C. Ginsburg
Published in Columbia - VLA Journal of Law & the Arts, Vol. 24, Fall 2000
1998 ended with voluminous copyright legislation, pompously
titled the "Digital Millennium Copyright Act" ["DMCA"], and intended
to equip the copyright law to meet the challenges of online digital exploitation of works
of authorship. 1999 and 2000 have brought some of the ensuing
confrontations between copyright owners and Internet entrepreneurs to the courts. The
evolving caselaw affords an initial opportunity to assess whether the copyright law as
abundantly amended can indeed respond to digital networks, or whether the rapid
development of the Internet inevitably outstrips Congress' and the courts' attempts to
keep pace. This Article addresses recent Internet-related controversies concerning
technological protection measures and copyright management information; fair use and
linking; "private" copying online services; and choice of law issues posed by
foreign websites accessible in the U.S.
The Internet copyright cases this Article examines call not only for interpretation of the
provisions of the DMCA, but also for application of principles developed in pre-DMCA cases
involving digital media and digital networks. What may make the current controversies
different is the intensity of their impact on end-users. While the defendants in the
current cases are generally, albeit not exclusively, commercial intermediaries, many of
the practices here at issue pose the prospect of mass uncompensated copying by the public.
Hence the feeling of desperation and even moral outrage that one senses pervades many of
the copyright owners' actions. From the user perspective,
digital media offer unparalleled opportunities to access and enjoy copyrighted works;
copyright owners' endeavors to staunch the free (as in unpaid) flow of works are misguided
attempts to stop the inexorable forward march of technology for the sake of preserving
mastodontic business models of distribution. Certainly the Internet will compel adoption
of new business models, and the sooner
copyright owners adapt, the better. The tools the DMCA and copyright caselaw give
copyright owners to confront copyright use on the Internet should be employed to promote
broad distribution of works of authorship at reasonable, and variable, prices. If
copyright owners instead wield these tools to enhance control without facilitating
dissemination, we can expect to see courts expand the zones of excused uses, whether or
not the excuses are doctrinally persuasive. Copyright owners cannot, and should not,
control every Internet use, but neither should every use prompt an excuse, lest we
undermine the ability of copyright owners, and especially of individual creators, to make
a living from their creativity.
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Ronald J. Gilson
June 2000
The coincidence of the new millennium and the fifteenth anniversary of the Delaware Supreme Court's announcement of a new approach to takeover law provides an appropriate occasion to step back and evaluate a remarkable experiment in corporate law - the Delaware Supreme Court's development of an intermediate standard for evaluating defensive tactics. I will argue that Unocal has developed into an unexplained and, I think, inexplicable preference that control contests be resolved through elections rather than market transactions. In doing so, I will highlight the remarkable struggle between the Chancery Court and the Supreme Court for Unocal's soul, a contest I will suggest the Supreme Court won only by fiat. I will also maintain that the current debate over shareholder-adopted bylaws that repeal or amend director-adopted poison pills provides a vehicle to reposition Delaware takeover law. Finally, I will end my retrospective on a note of praise. Intertwined with the development of Delaware takeover law is a reassessment and important expansion of the role of independent directors in corporate governance. There is no reason why this important development cannot be preserved if the Delaware Supreme Court chooses otherwise to restore balance to the law of takeovers.
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Victor P. Goldberg
August 2000
The UCC and common law have used "good faith" to interpret long-term, open quantity contracts in a manner which ignores the parties’ allocation of discretion. With no theory to guide them, courts have rewritten contracts to say, in effect, that a seller agrees to keep running his factory at a loss in order to generate waste (the waste removal company being the purchaser under the long-term contract) or that a buyer in a long-term requirements contract has promised to never run its facility at full capacity. Commentators have routinely accepted these interpretations without recognizing the peculiar features of this default rule. The simple theoretical point is that a long-term contract will often grant one party discretion with regard to quantity, in the form of output or requirements contracts, to adapt to changed circumstances. That discretion will typically be constrained by the requirements (or output) of a particular facility. To protect the opposite party’s reliance, the contract will often impose additional constraints on that discretion so that the first party must take this reliance seriously when making quantity decisions. The paper analyzes a number of cases from this perspective and concludes that, with the possible exception of cases in which the buyer eliminates its requirements by selling the plant, the courts should not use good faith to override the contractual allocation of discretion.
Download this paper in Acrobat formatLabor Federalism in the United States: Lessons
for International Labor Rights
Mark Barenberg
Journal of International Economic Law, Vol. 3(2), pp. 303-329, June 2000
Before the 1960s, United States regulatory institutions effectively enforced the principle that interstate commerce in goods produced in violation of workers' rights of association is an unfair trade practice. Thereafter, the same institutions facilitated the de facto non-enforcement of those core labor rights. This experience is best understood through regulatory models of 'coordinated decentralization'. The experience of United States labor federalism points to several institutional features that are likely to prove critical to the success or failure of any supranational architecture for enforcement of international labor rights, including: the regulatory endogeneity of interest groups; the structure of non-governmental institutions that span the tiers of federal public institutions; the mechanisms that mutually reinforce procedural and substantive rights of association; and the public-private networks that seek economic growth through agglomeration of human physical capital or, instead, through minimization of unit labor costs.
This paper available through the Journal of International
Economic Law - Oxford University Press
www.jiel.oupjournals.org
The Globalization of Corporate Governance:
Convergence of Form or Function
Ronald J. Gilson
May, 2000
This paper examines the interplay between selection-driven functional adaptivity on the one hand, and formal institutional persistence or path dependency othe other, that will determine whether such corporate governance convergence as we observe will be formal or functional. Five combinations of formal and functional covergence are considered: 1)purely functional convergence, as with the displacement of inefficient management; 2) the use of formal tools to catalyze the breakdown of formal barriers to functional convergence as with the elimination of tax on the sale of cross holdings; 30 the need for elements of both formal and functional convergence as with the creation of the institutional infrastructure that supports a venture capital market; 4) convergence by contract as with security design or foreign stock exchange listing; and 5) convergence through regulatory competition -- the hybrid of private and public ordering introduced to the European Community by the European Court of Justice's recent decision in Centros.
Download this paper in Acrobat formatSticks and Snakes: Derivatives and Curtailing Aggressive Tax Planning
David M. Schizer
Forthcoming in the Southern California Law Review, September 2000
Complex "derivative" financial instruments are often used in aggressive tax planning. In response, the government has implemented mark-to-market type reforms, but only partially. Considered in isolation, these incremental reforms are likely to seem well advised in measuring income more accurately. However, there is an important "second best" cost, emphasized in this Article: the ability of well-advised taxpayers either to avoid the new rule or to turn it to their advantage (here called "defensive" and "offensive" planning options, respectively). This Article uses two case studies to identify how these planning options arise and to suggest ways of combating them in future reforms. The first case study, Section 475, requires securities dealers to use mark-to- market accounting. Although this rule curtails tax planning by securities dealers themselves, it enables dealers to serve as accommodation parties for their clients’ tax planning: Once exempted from generally applicable rules, dealers can offer clients a tax benefit (e.g., accelerated losses) without experiencing a corresponding tax cost (e.g., accelerated income). The second case study, the contingent debt regulations, requires lenders and borrowers to report pre-realization gains and losses based on assumed annual returns. Although this reform seeks to accelerate the lender’s interest income, the rule’s narrow scope allows tax-sensitive lenders to avoid this result. Accordingly, the new rule is likely to apply only when tax-exempt entities lend to tax-sensitive borrowers, who enjoy the regulations’ accelerated interest deductions. This Article offers ways to remedy these reforms, as well as general guidance about how to implement incremental mark-to-market reforms without exacerbating the planning option. Download this paper in Acrobat formatRoman Frydman, Marek P. Hessel & Andrzej Rapaczynski
April 1998
This paper, based on a study of mid-sized firms in the Czech Republic, Hungary, and Poland, seeks to explain the reasons behind the marked impact of ownership on firm performance which has been observed in a number of studies in Eastern Europe and other parts of the world. Focusing in particular on the differential impact of ownership on revenue and cost performance, the paper argues that privatized firms controlled by outside investors are more entrepreneurial than those controlled by corporate insiders or the state. The paper provides evidence that all state and privatized firms in transition economies engage in similar types of restructuring, but that product restructuring by firms owned by outsider investors is significantly more effective (in terms of revenue generation) than that by firms with other types of ownership. The paper also examines the impact of managerial turnover on revenue performance, as well as differences among managers of firms with different types of ownership, and concludes that the more entrepreneurial behavior of outsider-owned firms is due primarily to incentive effects, rather than human capital effects, of privatization. More specifically, the authors argue that the success of outsider-owned firms is due to their greater readiness to accept risks (as evidenced by the higher variance of the revenues generated by restructuring) and a lesser need to defend, and account for, their managerial decisions.
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Roman Frydman, Cheryl W. Gray, Marek P. Hessel & Andrzej Rapaczynski
Published in Quarterly Journal of Economics, Vol. 114, Issue 4, pp. 1153-1191, November 1999
This paper compares the performance of privatized and state
firms in the transition economies of Central Europe, while controlling for various forms
of selection bias. It argues that privatization has different effects depending on the
types of owners to whom it gives control. In particular, privatization to outsider, but
not insider, owners has significant performance effects. Where privatization is effective,
the effect on revenue performance is very pronounced, but there is no comparable effect on
cost reduction. Overlooking the strong revenue effect of privatization to outsider owners
leads to a substantial overstatement of potential employment losses from
post-privatization restructuring.
This paper available through MIT Press
http://mitpress.mit.edu/QJEC
William M. Sage
Published in Columbia Law Review, November 1999
Efforts to reform the American health care system through direct government action have failed repeatedly. This article evaluates an alternative strategy that has emerged from these experiences: requiring insurance organizations and health care providers to disclose information to the public. Mandatory disclosure laws have become a focal point of current health care regulation, particularly as a response to the growth of managed care. The article traces the current popularity of disclosure laws to several developments, ranging from technical advances in health policy research to changes in social attitudes towards government. The article identifies four arguments for mandatory disclosure in health care, associates each with evolving trends in the law, and analyzes their implications for public policy. The article reveals that the most commonly articulated goal of disclosure laws, improving the efficiency of private purchasing decisions by giving purchasers complete information about price and quality, is the most complicated operationally. Other justifications for disclosure laws hold greater promise, but make different, sometimes conflicting assumptions about sources and uses of information. For example, using disclosure to ensure that intermediaries upon whom patients and consumers rely are in fact serving their interests suffers from potentially crippling ambiguities because agency relationships in health care are not limited to contractable matters. Similarly, public disclosure can stimulate innovation and improve the performance of the health care system in achieving organizational and national goals, but setting those goals implies influencing rather than honoring consumer preferences. Finally, although information can expose to democratic deliberation the social tradeoffs implicit in current health policy -- including public investment and procedural fairness -- the welfare consequences of transparency are indeterminate. The lessons that emerge from the article's analysis have implications not only for health care, but for other regulated practices and industries.
This paper available through Columbia Law Review
www.columbialawreview.org
David M. Studdert, William M. Sage, Carole R. Gresenz & Deborah R. Hensler
Published in Health Affairs, Vol. 18, November/December 1999
Policymakers are considering legislative changes that would increase the
exposure of managed care organizations to civil litigation for withholding coverage or
failing to deliver needed care. Using a combination of empirical information and
theoretical analysis, we assess the likely responses of health plans and ERISA plan
sponsors to an expansion of liability, and evaluate the policy impact of those moves. We
conclude that the direct costs of liability are uncertain, but that the threat of
litigation may have other important effects on coverage decision-making, information
exchange, risk contracting, and the willingness of employers to continue active
involvement in health coverage. Before legislators turn up the legal heat on managed care
organizations, they should carefully consider the broader implications of global warming
in the health care system.
This paper available through Health Affairs:
http://www.projhope.org/HA/novdec99/180602.htm
William M. Sage & Peter Hammer
Published in University of Michigan Journal of Law Reform, Vol. 32, No. 4, pp. 1069-1118, 1999
As American health care moves from a professionally dominated to a market-dominated model, concerns have been voiced that competition, once unleashed, will focus on price to the detriment of quality. Although quality has been extensively analyzed in health services research, the role of quality in competition policy has not been elucidated. While economists may theorize about nonprice competition, courts in antitrust cases often follow simpler models of competition based on price and output, either ignoring quality as a competitive dimension or assuming that it will occur in tandem with price competition. This unsystematic approach is inadequate for the formulation of policy in the health care industry, where quality is a central concern of both consumers and society. Instead, courts need a framework with which to analyze the implications for quality of various market structures and to understand the welfare implications of proposed market changes. A competition policy would seek to evaluate the potential for private markets to protect and improve quality in the health care system. This article examines the present influence of antitrust law on price-quality and quality-quality tradeoffs in health care, explores the issues that would be confronted in developing a true competition policy and outlines a research agenda that would begin to accomplish that task.
This paper available through Michigan Journal of Law Reform:
As part of a Managed Care Symposium - Contact Maureen
Bishop or www.law.umich.edu/pubs/journals/mjlr
Curtis J. Milhaupt and Mark D. West
Published in University of Chicago Law Review, Vol. 76, p. 41, 2000
This Article provides theoretical and empirical support for
the claim that organized crime competes with the state to provide property rights
enforcement and protection services. Drawing on extensive data from Japan, this Article
shows that, like firms in regulated environments everywhere, the structure and activities
of organized criminal firms are significantly shaped by state-supplied institutions.
Careful observation reveals that in Japan, the activities of organized criminal firms
closely track inefficiencies in formal legal structures, including both inefficient
substantive laws and a state-induced shortage of legal professionals and other
rights-enforcement agents. Thus, organized crime in Japan--and, by extension, in other
countries where significant gaps exist between formal property rights structures and state
enforcement capacities--is the dark side of private ordering.
Regression analyses show negative correlations between membership in Japanese organized
criminal firms and (a) civil cases, (b) bankruptcies, (c) reported crimes, and (d) loans
outstanding. We interpret these data to support considerable anecdotal evidence that
members of organized criminal firms in Japan play an active entrepreneurial role in
substituting for state-supplied enforcement mechanisms and other public services in such
areas as dispute mediation, bankruptcy and debt collection, (unorganized) crime control,
and finance. We offer additional empirical evidence indicating that arrests of gang
members do not curb the growth of organized criminal firms. These findings may have a
significant normative implication for transition economies: efforts to eradicate organized
crime should focus on the alteration of institutional incentive structures and the
stimulation of competing rights-enforcement agents rather than on traditional
crime-control activities.
This paper available through Chicago Law Review
Does Venture Capital Require an Active Stock Market?
Bernard S. Black and Ronald J. Gilson
Published in Journal of Applied Corporate Finance, pp. 36-48, Winter 1999
The United States has both an active venture capital industry and well-developed stock markets. Japan and Germany have neither. We argue here that this is no accident -- that venture capital can flourish especially -- and perhaps only -- if the venture capitalist can exit from a successful portfolio company through an initial public offering (IPO), which requires an active stock market. Understanding the link between the stock market and the venture capital market requires understanding the contractual arrangements between entrepreneurs and venture capital providers especially the importance of exit by venture capitalists and the opportunity, present only if IPO exit is possible, for the venture capitalist and the entrepreneur to enter into an implicit contract over control, in which a successful entrepreneur can reacquire control from the venture capitalist by using an IPO as the means of exit.
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Roman Frydman, Cheryl W. Gray, Marek P. Hessel and Andrzej Rapaczynski
February 1999
This paper, based on a large sample of mid-sized manufacturing firms in the Czech Republic, Hungary and Poland, argues that the imposition of financial discipline is not sufficient to remedy ownership and governance-related deficiencies of corporate performance. The study offers three main conclusions. First, we find that state enterprises represent a higher credit risk both because of their inferior economic performance and because of their lesser willingness or propensity to meet their payment obligations. Second, the brunt of the state firms' lower creditworthiness is borne by their state creditors, as state enterprises deflect the higher risk away from private creditors. Third, this transfer of risks from private to state creditors is possible because state creditors impose significantly "softer" financial discipline on state firms. Inasmuch as such softness may reflect unwillingness to accept a likely demise of a large number of state firms that are in principle capable of successful restructuring through ownership changes, we conclude that the imposition financial of financial discipline is not sufficient to remedy ownership and governance-related deficiencies of corporate performance.
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Victor P. Goldberg
February 29, 2000
By analyzing two American contract law decisions, the paper illustrates the usefulness of economic analysis in framing the inquiry. The cases have a common feature, unrecognized by the courts: they both deal with the production and transfer of information regarding the sale of an asset of uncertain value. One involves the combination of an option and a lockup to encourage the buyer to produce information. The other involves contingent compensation to convey the seller’s assurance of the quality of the assets. Once this is recognized, the outcomes are straightforward.
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Michal S. Gal
April 30, 2000
One of the most important market imperfections in modern capitalism and surprisingly one of the most under-regulated is oligopoly pricing (conscious parallelism). Only few suggestions have been made over the years to regulate oligopoly pricing. All suggestions pose serious obstacles to their efficient application. Accordingly, oligopoly pricing is not regulated. It is left to the workings of the market (or pure luck), while acknowledging the market’s limited regulatory force. This article proposes a novel method for regulating oligopoly pricing by way of introducing a government-supported maverick into an oligopolistic industry for a limited time. The maverick will price its products at competitive or near-competitive levels, based on considerations of consumer or total welfare. Its rivals will follow its pricing strategy, or incur significant losses and possibly exit the market. As will be shown, the proposal may significantly reduce allocative inefficiency by reducing the welfare losses from supra-competitive pricing. The threat of intervention might be sufficient, in itself, to reduce the problem of oligopoly pricing. It may also reduce productive inefficiency by combating the problem of inefficient plant and firm sizes. This article analyzes the market conditions that must exist for this proposal to be operational and points to its benefits as well as its costs and limitations.Download this paper in Acrobat
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Michal S. Gal
March 31, 2000
Current law and economics literature identifies two main types of errors courts can make in applying antitrust law. Courts may erroneously label a conduct as anti-competitive although competition is not harmed. Alternatively, courts may fail to identify anti-competitive conduct and thus fail to attack it. This article focuses on a third possible error where a court identifies, correctly, anti-competitive conduct but its mode of interference, its proscribed remedy, harms competition. It analyzes such error in the context of anti-competitive contract reformation. Such error occurs, for example, where a court has chosen a reformation option that is less efficient and effective than an alternative reformation option. Accordingly, this article identifies a set of clear and coherent principles for contract reformation in order to eliminate, or at least reduce, the occurrence of the third error. The analysis moves beyond the received wisdom that contract reformation should simply sever the anti-competitive parts of a contract if so doing does not alter the nature of the contract, and suggests that in most cases courts should invalidate the contractual relationship in its entirety.
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Jeffrey N. Gordon
January 31, 2000
Published in Columbia Journal of European Law, Vol. 5, No. 219, Spring 1999 (Symposium Issue)
A central question in the corporate convergence debate is the extent to which parties will settle on a shareholder capitalism model, in which managerial accountability will be measured against a public shareholder wealth maximization criterion. The paper evaluates two particular events for the impact on German corporate governance: the privatization of Deutsche Telekom and the cross-border merger between Daimler Benz and Chrysler Corp. The Deutsche Telekom transaction had symbolic impact, because it made many Germans shareholders for the first time, but the terms of the transaction substantially protected these shareholders against equity risk and deprived them of governance rights. The DaimlerChrysler merger, on the other hand, is a major event in governance convergence because it should inject a substantial element of US-style shareholder activism into the governance of a major German corporation. The paper identifies several elements, including: the change in the shareholder body through a dilution of traditional German holders and the addition of U.S. institutional investors, the pioneering of a template for subsequent cross-border mergers involving German firms, the flexibility of German corporate law to shareholder initiatives, and the likely rippling impact of governance changes at DaimlerChrysler on other major German corporations.
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Curtis J. Milhaupt
December 1, 1999
About the Project: This paper will be part of a Handbook of Korean Unification designed to provide policymakers with a "blueprint" for a unified Korea. The project is sponsored by the Korean Economic Research Institute and the Columbia Law School Center for Korean Legal Studies. The project team is comprised of eighteen scholars from South Korea, the United States, and Germany with expertise in economics, law, political science, and sociology. The project team is charged with drawing on the German experience with unification to provide in-depth analysis and policy recommendations with respect to major aspects of Korean unification.
Abstract: Drawing on lessons from privatization experiences in Germany and Central Europe, the paper outlines a step-by-step approach to the privatization of North Korean state-owned enterprises. The strategy is designed to obtain the corporate governance benefits of a sales-only approach to privatization and the social and political benefits of voucher-based mass privatization programs. A central lesson from past privatization experience is that law matters: simply moving ownership from state to private hands in an institutional vacuum does not ensure that adequate corporate governance and supervisory mechanisms will develop spontaneously. Thus, assuming South Korean economic institutions will serve as the template for a unified Korea, continued reform of South Korean corporate and securities laws is a crucial component of any well-devised privatization strategy.
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Robert Daines
November, 1999
Delaware corporate law rules are the nation's most
important. They govern roughly 50% of Fortune 500 firms and more than 60% of all publicly
held assets. However, scholars disagree about whether Delaware law improves or reduces
firm value. Some claim that Delaware law increases firm value, others claim that it
facilitates managerial rent seeking and still others argue that it is no different from
other states'.
I present evidence consistent with the theory that Delaware law improves firm value. Using
Tobin's Q as an estimate of firm value, I find that firms subject to Delaware corporate
law are worth significantly more than similar firms in other jurisdictions. The result is
robust to controls for firm size, diversification, profitability, investment opportunity
and industry. Delaware firms also receive significantly more takeover bids and are more
likely to be acquired. This suggests that Delaware law reduces the cost of acquiring
Delaware firms, thereby facilitating the sale of the firm and improving firm value.
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John C. Coffee, Jr.
October 20.1, 1999
Published in The Journal of Corporation Law, Vol. 25, No. 1, Fall 1999
This paper analyzes the comparative experiences of Poland
and the Czech Republic with voucher privatization. Because of a number of similarities
between these two transitional economies, it finds their comparative experience to provide
a useful natural experiment, with the critical distinguishing variable being their
different approaches to regulatory controls. However, while their experiences have been
very different, their substantive corporate law was very similar. The true locus of
regulatory differences appears then to have been the area of securities market regulation,
where their approaches differed dramatically.
Re-examining the work of LaPorta, Lopez-de-Silanos, Shleifer & Vishny, this paper
submits that (1) the homogenity of both common law systems and civil law systems has been
overstated; (2) common law systems in particular differ widely in terms of substantive
corporate law, but have converged functionally at the level of securities regulation; (3)
dispersed ownership will likely not persist under civil law systems that contemplate
concentrated ownership and hence do not address or discourage rent-seeking corporate
control contests or other forms of expropriation from minority shareholders; and (4) such
"winner-take-all" control contests are probably most feasibly addressed through
"self-enforcing" structural protections, such as (following the Polish model)
the transitional use of state-created controlling shareholders.
Reformulating the thesis originally advanced by LaPorta, et al., this article argues that
civil law systems are not inherently unprotective of minority shareholders, but rather
protect shareholders only against the forms of abuse that were well-known in systems of
concentrated ownership (i.e., typically, abuse by a dominating parent) and not against the
abuses that typically characterize systems of dispersed ownership (i.e., managerial
expropriation and theft of the control premium). Ultimately, there is a conceptual
mismatch between civil law systems and the dispersed ownership created by voucher
privatization.
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Gillian K. Hadfield
October 1999
Forthcoming in Michigan Law Review,
Vol. 98, No. 4, Feb. 2000
This paper begins with the question, Why do lawyers cost so
much? The analysis is an investigation of the imperfections in the market for lawyers,
imperfections that have been largely overlooked by focus on either the model of perfect
competition or the impact of artificial barriers to entry into the provision of legal
services. The paper catalogues multiple sources of imperfection: the nature of the
incentives and mechanisms at work to determine the level of complexity in the system, the
extent to which complexity and uncertainty make legal services into credence goods par
exellence, the winner-take-all and tournament nature of the competition among lawyers, the
sunk costs of lawyer-client relationships and hence the potential for opportunism and the
limited potential for conventional market mechanisms to control opportunism, the
incremental nature of legal fees—which structures legal expenditures as a sunk cost
auction in which the cost of services can easily and rationally exceed the amount at
stake, and three sources of monopoly: the familiar monopoly established by artificial
barriers to entry, the “natural” monopoly arising from the limited supply of
individuals in the economy with the cognitive skills necessary to engage effectively in
competitive legal reasoning, and the state’s monopoly over coercive dispute
resolution.
The analysis uncovers deeply disturbing implications for justice from the economics of the
market for lawyers. The price dynamics of the system operate within the framework of a
unified profession/unified legal system that essentially puts individual clients—with
justice interests at stake—into a bidding contest with corporate clients with
efficiency (more generally, market) interests at stake. Corporations by definition are
aggregations of individual wealth and as a consequence are able to bid for the resources;
they also are a richer feeding ground for the wealth extraction generated by the
imperfections/monopoly aspects of the market for lawyers. This is not an ethical critique
of lawyers; it is the implication of ordinary economic response to incentives structured
by a non-competitive market.
The economic dynamics of the market for lawyers operate like a vacuum, drawing the
resources of the system into the corporate sphere, in the service (from a public
perspective) of efficiency, and away from the individual sphere in the service of justice
as in the relationships between the individual and the state, the market, the family, the
community and so on. This stands on its head the lexicographic relationship between
efficiency and justice: efficiency is of normative significance only to the extent it
promotes individual welfare through just social relations.
The implications of the economic analysis in the paper are supported by the empirical
evidence we have about the structure of the legal profession and the changes over the past
several decades. The profession is roughly divided into two segments—one serving
business clients and one serving individual clients. The business segment is populated by
lawyers who graduated from elite institutions, who are well-connected and influential in
the profession, who charge high fees and earn high incomes and who are perceived to be in
short supply. These lawyers work in large firms or high-end boutiques and are increasingly
likely to be specialized. Their work is perceived to be of the highest level of prestige
by all members of the profession. The personal segment is populated by lawyers who
graduate from lower-tier schools, charge lower fees and often flat fees set in apparently
competitive fashion providing largely routine, non-contested legal services such as house
closings, uncontested divorces and wills. Their work is perceived, by them and the rest of
the profession, as low prestige. Lawyers in this segment tend to work in solo practice or
small general practice firms. The supply of lawyers in this segment is perceived to exceed
demand and there is evidence of un/underemployment and falling prices.
The allocation of total hours spent by lawyers on legal work is increasingly skewed
towards the business segment of the profession, and thus towards the efficiency and away
from the individual justice goals of the justice system.
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John C. Coffee, Jr.
December 2, 1999
Published in Columbia Law Review, Vol. 100, No. 2, pp. 370-439, March 2000
This paper assesses the prospects for meaningful reform of the class action after Amchem Products v. Windsor and Ortiz v. Fibreboard Corp. It reads these decisions as viewing "class cohesion" as the essential rationale that legitimizes representative litigation. Although it agrees that a legitimacy principle must underlie representative litigation, it doubts that "class cohesion" can bear that weight, either as a theory of political representation or as an economic solution for the agency cost and collective action problems in representative litigation.
Instead, using the familiar terminology of "exit," "voice" and "loyalty," it suggests that "exit" should prove a superior remedy to voice, and can be implemented through procedures that use exit (much like the appraisal remedy in corporate law) to discipline unfaithful fiduciaries. More generally, it argues that the same accountability mechanisms that work in the field of corporate governance should work in this context as well.
Because Amchem and Ortiz may be read to require overly rigorous procedural requirements that could lead to what this article terms the "Balkanization" of the class action, this article further suggests that "exit" should sometimes constitute a functional substitute for "voice" or "loyalty." As a remedy, "exit" can be structured so as to maximize individual choice and promote competition between non-overlapping classes. Thus, the benefits of competition can be realized without increasing the risk of collusion or a "reverse auction."
On the normative level, a choice must be made between viewing the class as an entity and viewing it as an aggregation of individuals. This article argues for the latter view and posits that the basic fiduciary duty of the counsel in representative litigation should be to protect client autonomy.
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Political Foundations for Separating Ownership From Corporate Control
Mark J. Roe
Published in Stanford Law Review, Vol. 53, December, 2000
The large public firm dominates business in the United States despite its critical infirmities, namely the frequently fragile relations between stockholders and managers. Managers’ agendas can differ from shareholders’; tying managers tightly to shareholders has been central to American corporate governance. But in other economically-advanced nations ownership is not diffuse but concentrated. It is concentrated in no small measure because the delicate threads that tie managers to shareholders in the public firm fray easily in common political environments, such as those in the continental European social democracies. Social democracies press managers to stabilize employment, to forego even some profit-maximizing risks with the firm, and to use up capital in place rather than to down-size when markets no longer are aligned with firm’s production capabilities. Since managers must have discretion in the public firm, how they use that discretion is crucial to stockholders, and social democratic pressures on managers induce them to stray from their shareholders’ preference to maximize profits. Moreover, the means that align managers with diffuse stockholders in the United States—incentive compensation, transparent accounting, hostile takeovers, and strong shareholder-wealth maximization norms—are harder to implement in continental social democracies. Hence, public firms in social democracies will, all else equal, have higher managerial agency costs, and large-block shareholding will persist as shareholders’ next best remaining way to control those costs. Indeed, when we line up the world’s richest nations on a left-right continuum and then line them up on a close to diffuse ownership continuum, the two correlate powerfully. True, the effects on total social welfare are ambiguous; social democracies may enhance total social welfare, but if they do, they do so with fewer public firms than less socially-responsive nations. We thus uncover not only a political explanation for ownership concentration in Europe, but also a crucial political prerequisite to the rise of the public firm in the United States, namely the absence of a strong social democracy and the concomitant political pressures it would have put on the American business firm.
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Shareholder Litigation Under Indeterminate Corporate Law
Ehud Kamar
Published in University of Chicago Law Review, Vol. 66, pp. 887-914, 1999
Insurance and indemnification of directors and officers for liability incurred in shareholder fiduciary claims presents a puzzling circularity, whereby shareholders protect directors and officers from suits that shareholders themselves bring. Nevertheless, liability insurance and indemnification can be efficient as a decoupling mechanism that allows courts to compensate plaintiffs for their litigation expenditures without overburdening defendants. The resulting combination of low sanctions and frequent enforcement can address the open-ended nature of fiduciary standards in two ways. First, it develops and clarifies the law through the creation of precedents and the accumulation of judges' and lawyers' experience. Second, it reduces the liability risk that directors and officers bear by making the occurrence of litigation more certain. That liability insurance and indemnification can be efficient does not mean, however, that it is efficient as practiced today. While current insurance and indemnification practices address indeterminacy by generating litigation, it is not clear that this indeterminacy is in itself desirable nor that it is addressed optimally.
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Japanese Corporate Governance:
The Hidden Problems of the Corporate Law and Their Solutions
Zenichi Shishido
April 8, 1999
It has long been said that the Japanese corporate governance does not pay sufficient attention to shareholders as the owners of the corporation. And yet, despite this seeming lack of shareholder ownership, Japanese firms have performed quite well until recently. This paper seeks to solve this conundrum by developing the "Company Community" concept as a positive model of the Japanese corporate governance. This model is used to illustrate how the Japanese system of corporate governance solves the hidden problems of the corporate law. These hidden problems of corporate law are common to all developed economies and consist of the dual problems of balancing between monitoring and autonomy of management and balancing between money capital and human capital.The company community concept solves these problems through an intricate system of monitoring consisting of three levels. The first level is the in-house monitoring by core employees who are quasi-residual claimants and monitor management as a participant in the Community. The second level is the monitoring by cross-shareholders in the firm, the main bank in particular. Cross-shareholding also has the effect of stabilizing the management position against outside control. The third level is the monitoring by exit of the outside shareholders. These multiple levels of monitoring have the effect of stabilizing management yet upholding shareholder ownership as the end game norm.
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Financial Slack Policy and The Laws of Secured Transactions
George G. Triantis
Published in Journal of Legal Studies, Vol. 29, p. 35, 2000
A manager’s discretion depends on the firm’s internal funds and its capacity to issue low-risk debt (together "financial slack"). The optimal amount of financial slack is a challenging problem in corporate finance. Too much slack encourages managerial misbehavior and exacerbates corporate agency problems. Too little slack prevents the firm from exploiting profitable investment opportunities. The various features of financial leverage -- including the amount of debt, maturity, covenants and default rights, and collateral -- may be used to regulate the degree of slack in a firm. This paper demonstrates how (1) the priority rules and (2) the property rights in collateral and proceeds associated with security interests under each of U.C.C. Article 9 and the Bankruptcy Code contribute to optimal slack policy.
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Corporate Law and Social Norms
Melvin A. Eisenberg
May 21, 1999
Corporate law serves both to facilitate and to regulate the conduct of the corporate enterprise. Insofar as corporate law is regulatory, it provides incentives and disincentives to the major actors in the corporate enterprise -- directors, officers, and significant shareholders -- through the threat of liability. In significant part, however, these actors are motivated not by the desire to avoid liability, but by the prospect of financial gain, on the one hand, and by social norms, on the other. Much work has been done on the way in which these actors are motivated by the threat of liability and the prospect of financial gain, but relatively little work has been done on the operation of social norms. In this Article, I examine the interrelation of social norms and law in corporate law. The purpose of this examination is to illuminate both corporate law specifically, and the interrelation of social norms and law generally, by studying ways in which that interrelation operates in a specific field. I focus on three kinds of social norms, which I call patterns, practices, and obligational norms.
The organization of the Article is as follows: I begin by describing and defining the kinds of social norms that are relevant to law. I then consider, in a preliminary way, the effects and origins of social norms. Finally, I examine the critical role of social norms in three central areas of corporate law: fiduciary duties (specifically, care and loyalty), corporate governance (specifically, board composition and the role of institutional investors), and takeovers. In the course of that examination, I apply and elaborate the introductory analysis concerning the kinds, origins, and effects of social norms, and consider some of the kinds of interrelations between social norms and law.
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The Conception that the Corporation is a Nexus of Contracts, and the Dual Nature of the Firm
Melvin A. Eisenberg
May 12, 1999
Published in 24 Journal of Corporation Law, P. 819, 1999
In 1976 Michael Jensen and William Meckling first formulated the conception that the corporation is a nexus of contracts in their famous article The Theory of the Firm-: Managerial Behavior, Agency Costs, and Ownership Structure. Since that time, the conception has dominated the law-and-economics literature in corporate law. The validity of this conception, however, cannot be established by economic analysis. That does not make the conception invalid, but it does mean that its validity must be examined along other dimensions. This Article examines the conception along several such dimensions, including its descriptive validity, its bearing on important problems of corporate law, and its intellectual coherence. One thesis of the Article is that the nexus-of-contracts conception is unsatisfactory as a positive -- that is, descriptive -- matter, in part because the corporation has a dual nature. In one aspect, the corporation consists of reciprocal arrangements. In another, it is a bureaucratic hierarchical organization. The nexus-of-contracts conception captures only one of these two aspects of the corporation. The Article also shows the conception lacks intellectual coherence, and often gets in the way of clear thinking by substituting conclusory assertions for careful analysis.Download this paper in Acrobat format
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Can the Graduated Income Tax Survive Optimal Tax Analysis?
Lawrence Zelenak and Kemper Moreland
Published in Tax Law Review, Vol. 53, p. 51-, 1999
Optimal tax analysis attempts to find the income tax rate structure which maximizes social welfare, under a chosen social welfare function (which can range from purely utilitarian to a Rawlsian maximin). It provides sophisticated mathematical techniques for balancing the welfare gains from redistribution against the welfare losses from the disincentive effects of taxation. Although the results of optimal tax simulations are sensitive to factual assumptions (relating to the rate at which the marginal utility of money declines, the strength of the disincentive effects of taxation, and the distribution of wage rates) and to the choice of social welfare function, one result is surprisingly robust: the marginal tax rate rises through the bottom decile of the societal wage distribution, but falls as income increases thereafter. These results provide high-level intellectual support for the attack on progressive marginal rates by the flat tax movement. To date, however, optimal tax simulations have uniformly assumed that much or all of the revenue raised by taxation will be used to finance universal cash grants ("demogrants"), and the combined effect of the cash grants and the regressive marginal rate structure has been optimal tax-and-transfer systems with progressivity of average (as contrasted with marginal) tax rates. The paper criticizes the demogrant assumption as politically unrealistic, and considers whether optimal marginal rates would continue to be regressive if demogrants are ruled out on political grounds–i.e., if the only purpose of taxation is to finance non-redistributive governmental functions. The paper reports on the results of a simulation which assumes no demogrants, a poverty-level exemption (zero bracket), and two rate brackets above the exemption. In that case, the second bracket rate should be higher than the first. In other words, without demogrants the optimal two-bracket tax system has progressive marginal rates. Thus the reliance on optimal tax analysis by flat tax proponents is inappropriate, if those proponents do not also support demogrants. The paper also surveys the optimal tax literature for other indications progressive marginal rates may be optimal under non-standard assumptions. In particular, progressive marginal rates may be optimal (even in the context of demogrants) if people care about relative levels of consumption, if there is significant wage uncertainty, or if the distribution of wage rates is different from that usually assumed.
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Japan's Experience with Deposit Insurance and Failing Banks:
Implications for Financial Regulatory Design?
Curtis J. Milhaupt
March 5, 1999
Abstract: This paper examines three decades of Japanese experience with deposit insurance and failing banks, and analyzes the implications of that experience for bank safety net reform in other countries. To date, the literature and policy debate on deposit insurance have been heavily colored by U.S. banking history and focus almost exclusively on explicit deposit protection schemes. Analysis of Japan’s safety net experience suggests that (a) deposit insurance, for all its flaws, is superior to the real-world alternative -- implicit government protection of depositors and discretionary regulatory intervention in bank distress, (b) a well designed explicit deposit insurance system which includes a credible bank closure policy is the starting point for the design of effective private alternatives to a government-run safety net, and (c) the trend toward greater institutionalization of the Japanese safety net -- culminating in recent legislation to address the financial crisis -- reflects increased political competition and greater emphasis on legal as opposed to reputational systems of economic ordering in that country.
JEL Classification: G21, K23, N25, N45
Key Words: Deposit Insurance, Bank Failure
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Executives and Hedging: The Fragile Legal Foundation of Incentive Compatibility
David M. Schizer
Published in Columbia Law Review, Vol. 100 No. 2, pp. 440-504, March 2000
Please consult author before citing this working draft of November 7, 1999. Comments are welcome at (212) 854-2599 or dschiz@law.columbia.edu
In the capital markets, the 1990s have been the decade of executive stock options and the derivatives market. Legal scholars and economists have begun to realize that, in combination, these two trends raise a serious concern. Options are supposed to inspire better performance by tying pay to the stock price. Yet, what if an executive could use the derivatives market to simulate a sale of her option – a practice known as "hedging" – without violating her contract with the firm? The incentive justification for option grants would no longer hold.
This Article demonstrates that the tax law helps avert this consequence in the United States; this phenomenon, in turn, shows that the U.S. tax law performs an important corporate governance function, not previously recognized in the academic literature. The tax law discourages executives from hedging options (but not necessarily from hedging stock holdings, although such hedging raises somewhat different concerns). Whereas shareholders and executives should contract to ban options hedging, the existing tax barrier is a plausible substitute. Indeed, since the tax law already has reason to monitor and penalize hedging, it can perform this corporate governance function without significant new administrative costs. Yet the tax barrier is overbroad and potentially unstable. Indeed, it could unravel due to relatively minor changes in the tax law that seem far removed from corporate governance. Moreover, the tax barrier does not govern foreign executives who are not subject to U.S. tax. Accordingly, this Article recommends strengthening contractual and securities law constraints on hedging. It concludes with reflections about the capacity of tax to influence corporate governance, not only for the worse, as has widely been observed, but also sometimes for the better.
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Obviousness and New Technologies
John Kasdan
The recent Court of Appeals for the Federal Circuit ("CAFC") decision in State Street Bank and Trust Co. v. Signature Financial Group has opened up a new area, methods of doing business, as patentable subject matter. This paper explores the institutional competence of the United States Patent Office ("USPTO") and the CAFC to administer patents in this new field. Analogies are drawn with another new technology, computer programming, which was only recently made eligible for patent protection. It is argued that entrenched doctrinal methods in the CAFC and historical staffing preferences in the USPTO make it likely that patents will be granted on innovations that are obvious, at least in the non-technical sense of that word. A suggestion is made for a legislative change which might ameliorate the problems caused by such patents, if they are issued, and the paper concludes with some speculations on the extent of the possible harm from such patents.
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Criminal Law and Behavioral law and Economics:
Observations on the Neglected Role of Uncertainty in Deterring Crime
Alon Harel and Uzi Segal
Two similarly situated individuals commit identical crimes. The first is sentenced to 10 years in prison while the second is sentenced to 5 years. The disparity between the two sentences of the criminals is a reason for concern. The person who is sentenced to 10 years has a legitimate moral complaint: why was I sentenced more harshly than she was. In contrast, two individuals commit identical crimes. When the first criminal commits the crime, the police invest few resources in detecting criminals of this particular sort. Consequently, the probability that the criminal will be detected is merely ten percent. When the second criminal commits the crime, the police conduct a major campaign against crimes of this sort and consequently the probability facing the second criminal is twenty percent. The latter case although creating disparate treatment of similarly situated criminals does not raise the same type of moral resentment raised by the first case. The moral concern of the person who asks "why me?" is compelling when there is a disparity in the sentences, but has no moral force when the relevant disparity is disparity with respect to the probability of detection.
Various established doctrines and practices reflect the difference in our moral intuitions between disparity with respect to the size of the sanction and disparity with respect to the probability of detection. Sentences are public; they constitute part of our criminal law. But no criminal code provides any information with respect to the rate of detection, or conviction. Moreover, a criminal sanction cannot be imposed retroactively in our system. On the other hand, a person who committed a crime while the probability of detection was low cannot complain that she was caught simply because the probability of detection increased after she had committed the crime. Last, the probability of detection often changes due to temporary enforcement campaigns initiated by the police. No analogous sentencing campaigns during which judges impose heavier sanctions relative to the ones imposed on criminals who are tried at other times exist in our legal system. In sum, criminal sanctions are public, relatively stable and consequently relatively predictable. In contrast, the practices governing the determination of the probability of conviction reinforce uncertainty.
The paper explores ways of reconciling the different treatments of certainty in the legal system. The overriding normative principle that governs the determination of certainty can be stated as follows. The criminal law system aims at providing maximum deterrence at minimal costs. The costs of the criminal law system are determined by the costs of sentencing and by the costs of the detection and conviction systems. Since the cost of sentencing depends on the average sanction, the first question to answer is what is worse from the potential criminal's point of view: a sentencing scheme which guarantees certainty with respect to the size of the sanction, or a sentencing scheme which does not guarantee such a certainty. Similarly since the costs of detection and conviction depend on the average probability of detection and conviction, the first question is what is worse from the potential criminal’s point of view: a detection and conviction scheme which guarantees certainty with respect to the probability of detection and conviction, or a scheme which does not guarantee such a certainty.
Once we discover which scheme is worse from the perspective of the criminal, the State should adopt this scheme since it has larger deterrent effects. Thus, if one finds out that potential criminals prefer a sentencing scheme that does not guarantee certainty, the State should adopt a sentencing scheme that is certain. Similarly, if one finds out that criminals prefer a sentencing scheme, which guarantees certainty with respect to the probability of detection and conviction, the State should adopt a sentencing scheme that guarantees uncertainty.
Our paper invokes insights from psychological experiments to examine the attitudes of criminals towards uncertainty and illustrates that criminals are likely to prefer a scheme in which the size of the sentence is uncertain while the probability of detection and conviction is certain. Consequently, we argue that the choice to increase certainty 1with respect to the size of the sentence and to decrease certainty with respect to the probability of detection and conviction can ultimately be justified on efficiency-based grounds.
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The Future as History: The Prospects for Global Convergence
in Corporate Governance and its Implications
John C. Coffee, Jr.
Published in Northwestern University Law Review, Vol. 93, No. 3, pp. 641-708, Spring 1999
No Abstract Available
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Board Independence and Long-Term Firm Performance
Sanjai Bhagat and Bernard S. Black
February, 2000
Previous version was titled: Do Independent Directors Matter? (WP # 112)
The boards of directors of American public companies are dominated by independent directors. Moreover, many commentators and institutional investors believe that independent directors should be even more numerically dominant on public company boards than they are today. We conduct the first large sample, long-horizon study of whether board independence (proxied by a "difference" variable equal to proportion of independent directors minus proportion of inside directors) correlates with the long-term performance of large American firms. Contrary to conventional wisdom, we find a negative correlation between board independence and various measures of firm performance and growth. This suggests that the current focus on board independence could be leading firms to employ too many independent directors and too few inside directors.
Download this paper in Acrobat formatIn Search of Best Efforts: Reinterpreting Bloor v. Falstaff
Victor P. Goldberg
Bloor v. Falstaff has become the standard casebook example of judicial interpretation of a "best efforts" clause. The court held that Falstaff’s lackluster promotional efforts for Ballantine beer violated its "best efforts covenant, a result that has met with near universal approval. However, when the problem is properly framed, the decision is clearly wrong. The court’s failure to consider the purpose of the transaction led it astray. Falstaff almost certainly did not breach its obligation.
The essential feature of the contract is that Ballantine was exiting the beer business and was making a one-shot sale of some of its assets to Falstaff. Ballantine wanted to receive the highest possible price and, other things equal, the fewer post-sale restrictions on Falstaff’s exploitation of the assets, the more Falstaff would be willing to pay. So, any restriction, like the best efforts clause, immediately raises a red flag: how might the particular restriction raise the value of the Ballantine assets, ex ante? The deal included an "earnout" designed to cope with the information asymmetries inherent in the transaction. A significant part of Ballantine’s compensation was in the form of a per barrel royalty. The role of the best efforts clause was to guard against the possibility that Falstaff could obtain the value from the Ballantine assets in a manner which bypassed the royalty. The poor performance of Ballantine beer post-acquisition was due not to Falstaff’s diversion of revenue, but to the poor quality of the Ballantine assets (and the changing conditions in the beer industry).
Download this paper in Acrobat formatBloomer Girl Revisited or How to Frame an Unmade Picture
Victor P. Goldberg
The standard analysis of Parker v. Twentieth Century Fox follows the court in focusing on whether the substitute employment offered Shirley MacLaine was "different and inferior" from that which she had initally contracted for. That, this paper argues, was the wrong question. The court managed to produce the right outcome, but through convoluted reasoning that failed to recognize the essential feature of the contract. The contract had a "pay-or-play" provision by which the studio, in effect, purchased an option on her time; they would pay her to be ready to make a particular film, but they made no promise to actually use her in making the film. Cancellation did not entail breach, and, therefore, it was unnecessary to ask whether she had failed to mitigate.
The paper traces the case through the courts, showing how the attention paid the pay-or-play feature declined. It then analyzes the economics of the pay-or-play clause. The clause gives the studio an option, giving it the flexibility to adapt or to abandon a project. The pay-or-play clause is a nuanced balancing of the studio's need for flexibility against the artist's reliance.
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Deutsche Telekom, German Corporate Governance, and the Transition
Costs of Capitalism
Jeffrey N. Gordon
Columbia Business Law Review 185, 1998
No Abstract Available
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Working Paper # 139
INFORMATION ASYMMETRY, THE INTERNET, AND SECURITIES OFFERINGS
Bernard S. Black
Published as part of a symposium on The Internet and Small Business
Capital Formation
Journal of Small and Emerging Business Law, pp. 91-99 ,1998
In this comment, prepared for a symposium on capital formation for small
businesses, I express doubts about whether the Internet, as a new communication medium,
will significantly reduce the cost of obtaining capital through a public or quasi-public
offering. The most important single barrier standing between small companies and capital
providers is information asymmetry potential investors do not know, and cannot easily
verify, the quality of the information that a company provides. The internet cannot do
much to reduce information asymmetry costs, nor the costs of the reputational
intermediaries that emerge in securities markets. On the contrary, the Internet could
increase information asymmetry costs by undercutting the effectiveness of the institutions
that today provide investors with partial assurance of the quality of the information
provided by issuers.
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Working Paper # 138
GENERAL PRINCIPLES OF COMPANY LAW FOR TRANSITION ECONOMIES
December 1996
In the context of the programme of the OECD's Centre for Co-operation with Non Member Economies (CCNM), a group of experts on company law was constituted to discuss and formulate a set of general principles of company law that can be of use to policy makers in the NIS as well as in other transition economies. These principles, presented in this publication, have four main aims: (1) to identify 'best practices' or main alternative approaches towards a modern company law, adapted to the special needs of transition countries; (2) to articulate these principles in a fashion that allows them to be used as a basis for on-going and future legislative reform; (3) to assist the drafters of model/comparative legislation in the transition context; and (4) help regulators and especially judges in interpreting and implementing existing and future legislation.
The CCNM is the focal point for the OECD's co-operation with transition economies in the Central and Eastern European Countries (CEECs) and the New Independent States (NIS) of the former Soviet Union. Its major responsibility is to design and manage a programme of policy dialogue which can take numerous forms, including conferences, seminars, expert meetings, and country specific advice in which policy questions can be explored and draft legislation reviewed. As part of its ongoing programme of assistance, the OECD, in co-operation with the Turkish International Co-operation Agency (TICA) and the German government, has created the Centre for Private Sector Development in Istanbul. This publication and related meetings were realised in the context of this Centre.
In September 1996 a small team of experts was constituted to draft the principles. The group included: Dr. Gainan Avilov, Senior Research Associate, The Russian Federation Government Institute for Legislative and Comparative Law; Professor Bernard Black, Columbia University School of Law, U.S.A. (general rapporteur); Professor Dominique Carreau, University of Paris I; Dr. Oksana M. Kozyr, Deputy Head of Department, the Research Centre for Private Law by the President of the Russian Federation; Mr. Stilpon Nestor, Head of the Privatisation and Enterprise Reform Unit (PERU) at the OECD; and Dr. Sarah Reynolds, Fellow, Davis Centre for Russian Studies, Harvard University, USA. The draft set of principles elaborated by the drafting team was submitted for discussion to a high-level experts group which met in Istanbul on 9-11 December 1996. Participants included senior representatives and company law experts from CIS countries and OECD member countries (see List of Participants).
Conclusions drawn at this meeting, following the presentation of the draft text and its
extensive discussion by the experts, form the basis for the general principles published
herein. These were finalised and edited in English by an OECD Secretariat team, which
included Stilpon Nestor, Frederic Wehrle . In view of the aim of the general principles,
it was decided to publish them simultaneously in Russian. Gainan Avilov and Oksana Kozyr
supervised the editing of the Russian version. These principles are published under the
responsibility of the Secretary-General.
Jean-Pierre Tuveri
Director for Co-ordination, CCNM
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Working Paper # 137
The Uncertain Relationship Between Board
Composition and Firm Performance
54 Business Lawyer 921-963, 1999
We survey the evidence on the relationship between board composition and firm performance. Boards of directors of American public companies that have a majority of independent directors behave differently, in a number of ways, than boards without such a majority. Some of these differences appear to increase firm value; others may decrease firm value. Overall, within the range of board compositions present today in large public companies, there is no convincing evidence that greater board independence correlates with greater firm profitability or faster growth. In particular, there is no empirical support for current proposals that firms should have "supermajority-independent boards" with only one or two inside directors. To the contrary, there is some evidence that firms with supermajority-independent boards are less profitable than other firms. This suggests that it may be useful for firms to have a moderate number of inside directors (say three to five on an average-sized eleven member board). We offer some possible explanations for these results, based on board dynamics, the informational advantages possessed by inside (and, often, affiliated) directors, and the value of interaction between different types of directors who bring different strengths to the board.
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Working Paper # 136
An Economic Analysis of the Guaranty Contract
Guaranty arrangements, in which one person stands as surety for a second person's obligation to a third, are ubiquitous in commercial transactions and in commercial law. In recent years, however, scholarly attention to the topic has been scant; and there is still no theoretical treatment of this body of law or practice from a economic policy perspective. This paper, accordingly, attempts to outline the basic economic logic underlying the guaranty relationship, and applies the results to a variety of specific issues in government policy and private planning. It poses and answers three main questions: First, why would a creditor prefer to make a guaranteed loan rather than an unguaranteed one? The answer is not as obvious as might first appear, given that market competition over credit terms tends to adjust the interest rate paid by an individual borrower to reflect the specific default risk that he presents. Second, given that they bear the residual risk of debtor default, why would guarantors prefer to guarantee loans rather than make loans directly, thus foregoing the opportunity to earn interest payments that could help to compensate for the risk they bear? Third, even if it is efficient for one creditor to provide funds and another to provide insurance against default, why would the parties prefer to implement this arrangement through the triangular form of a guaranty, instead of simply having the former creditor lend to the latter and the latter lend to the ultimate borrower?
Keywords: Contracts, commercial law, guaranties and suretyships, risk allocation.
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Working Paper # 135
The Shaping Force of Corporate Law in the New Economic Order
Published in University of Richmond Law Review, Vol. 31., No. 5, pp. 1473-, 1997
This article, based on an invited lecture, argues that the current
corporate governance regime plays an insufficiently appreciated role as a shaping force in
the current U.S. economic framework. The dominant corporate law norms and the particular
distribution of shareownership have combined to produce a responsiveness to capital market
signals that has made U.S. firms especially strong worldwide competitors. This
responsiveness, and the associated economic success, is at risk because of continuing
state legislative and judicial changes that increase management's ability to resist a
hostile takeover bid. Institutional investor ownership and activism is insufficient; legal
rules matter because they set the framework within which institutions (and catalytic
forces like control entrepreneurs) can act. The paper traces the emergence of this
corporate governance regime in the 1980s and 1990s, explains its importance to the
emerging economic order, and focuses specifically on the Virginia antitakeover statutes
and cases as a particularly troubling development.
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Working Paper # 134
Just Say Never?" Poison Pills, Deadhand Pills, and Shareholder-Adopted Bylaws:
An Essay for Warren Buffett
Jeffrey N. Gordon
Published in the Cardozo Law Review, Vol.
19, No. 2 (1997)
(Symposium on the Essays of Warren Buffett).
A series of important corporate governance questions are likely to be addressed by the
Delaware Supreme Court in the near future: whether a board can in fact "just say
no" to a hostile bid; whether a board can thwart a proxy fight to redeem a poison
pill through a "continuing director" provision in its pill (what might be called
"just say never"); and whether shareholders can use their power to amend bylaws
to constrain the adoption and maintenance of a pill. It is important that these questions
be resolved in a way that maintains a vibrant, if not unconstrained, corporate control
market. This is because control markets potentiate the use of capital market signals in
the monitoring of managerial performance, which is especially important in an especially
competitive domestic and global economic environment. Despite increasing institutional
investor activism, the realistic possibility of a hostile acquisition is a necessary
ingredient to an optimal corporate governance regime for large public corporations in a
stock-market centered capital markets system.
The article argues in doctrinal terms that "just say no" is not the rule in
Delaware and that, at a minimum, in the case of a firm with a staggered board the
retention of a poison pill beyond the insurgent's initial electoral success is no longer
reasonable. Similarly, pills with continuing director provisions (so-called "deadhand
pills") violate Delaware statutes that govern the constitution of the board and
director authority as well as fiduciary norms that protect the shareholder franchise.
Finally, since statutory formalism does not resolve the question of shareholder bylaw
amendment authority, the Delaware court should adopt a model of shareholder choice that
in, reserving residual governance authority for shareholders, would permit such a bylaw
that generally limited the use of poison pills.
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Working Paper # 133
Employee Stock Ownership in Economic Transitions: The Case of United Airlines
Jeffrey N. Gordon
Published in Bank of America Journal of Applied Corporate Finance, 1998
Employee stock ownership is usually discussed in terms of its normative desirability as a model of workplace relations or its general (in)efficiency properties. This paper considers employee stock ownership transactions as an adjustment mechanism for economic change. The starting point is the "employee stock ownership" is not a self-defining form and that specific institutions of economic participation and governance participation very much affect the viability of any particular transaction. The paper then considers the various rationales for employee stock ownership in situations of economic transition, rejecting claims of "just allocation" but suggesting that such transactions can overcome bargaining pathologies and thereby conserve the value of the firm. One important question is whether employee stock ownership transactions produce a transitional organizational form that quickly reverts to the standard firm or an organizational form that manages economic transitions in a superior way.
These issues are explored in the recent employee acquisition of a majority ownership of United Air Lines. The transaction provided for long-term employee ownership, not simply a transitional form, and so locked up the employee stock in an employee pension plan and provided employees with longterm governance rights. The evidence to date suggests that employee ownership has enhanced UAL's competitive position but that governance pressure from employees when their interests are directly at stake is a potentially destabilizing force.
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Working Paper # 132
Corporate Governance and The Voice of the Paparazzi
February 1999
This is one of a group of papers, at Brookings awaiting publication, celebrating the
remarkably sustained value of Albert Hirschman's "Exit, Voice & Loyalty,"
published in 1971. Those who know that book -- and everyone should -- recognize that
exit-voice has particular relevance in corporate governance. It is a conundrum:
shareholders "exit" at a turnstile pace -- turnovers of 75% a year in NYSE
stocks -- and shareholder "voice" only from a handful of state/local pension
funds. Why then has the American corporation come to be seen as the paradigm? The paper
focuses on the exceptionally high degree of financial transparency here, far better than
elsewhere, which with the high degree of public confidence and interest engendered thereby
have produced an extraordinary level of media attention -- the voice of the analysts and
other paparazzi -- helping greatly to explain the palace upheavals at GM, Kodak,
Westinghouse and elsewhere. Far from being an isolated phenomenon, it is simply one aspect
of a society and market structure that could function well only with pervasive sunshine.
The paper looks also at Germany, Japan, and (ach!) So. Korea and the like.
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Working Paper # 131
A Theory of Path Dependence in Corporate Governance and Ownership
November 1999
Published in Stanford Law Review, Vol. 52, pp. 127-170, October 1999
Corporate structures differ among the advanced economies of the world. We contribute to an understanding of these differences by developing a theory of the path dependence of corporate structure. The corporate structures that an economy has at any point in time depend in part on those that it had at earlier times. Two sources of path dependence—structure driven and rule driven—are identified and analyzed. First, the corporate structures of an economy depend on the structures with which the economy started. Initial ownership structures have such an effect because they affect the identity of the structure that would be efficient for any given company and because they can give some parties both incentives and power to impede changes in them. Second, corporate rules, which affect ownership structures, will themselves depend on the corporate structures with which the economy started. Initial ownership structures can affect both the identity of the rules that would be efficient and the interest group politics that can determine which rules would actually be chosen. Our theory of path dependence sheds light on why the advanced economies, despite pressures to converge, vary in their ownership structures. It also provides a basis for why some important differences might persist.
Working Paper #130
A Regulatory Competition Theory of Indeterminacy in Corporate Law
Updated version published in Columbia Law Review, Vol. 98, No. 8, pp. 1908-1959, December 1998
Corporate law in the United States is widely believed to be the product of competition among states in corporate chartering. States can attract incorporation by offering law that appeals to corporate decision-makers, and are motivated to do so in view of fiscal and other economic gains emanating from corporate chartering. Different opinions exist on the desirability of this competition. Race-to-the-bottom theorists contend that states lure incorporation by tailoring their law to the needs of self-serving managers, who dominate incorporation decisions. Race-to-the-top theorists concede that state law meets the needs of managers, but argue that the interests of managers and shareholders are aligned.
This article revisits both of these views. It argues that the market for corporate law
is uncompetitive, and therefore may not yield the optimal product either to shareholders
or to managers. Delaware dominates the market as a result of several competitive
advantages that are hard for other states to replicate. These advantages include network
benefits emanating from Delaware's status as the lead incorporation jurisdiction;
Delaware's proficient judiciary; and Delaware's unique commitment to corporate needs.
Delaware can enhance these advantages by developing indeterminate and judge-oriented law,
even if such law is not desirable. Indeterminacy makes Delaware law inseparable from its
application by Delaware courts and thus excludes non-Delaware corporations from network
benefits, accentuates Delaware's judicial advantage, and makes Delaware's commitment to
firms more credible. Whether state competition constitutes a race to the top, to the
bottom, or to somewhere in between, excessive indeterminacy may add an additional level of
inefficiency to the law.
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Working Paper # 129
Shareholder Activism and Corporate Governance in the United States
Published in The New Palgrave Dictionary of Economics and the Law (1998), Peter Newman, ed.
I survey corporate governance activity by institutional investors in the United States,
and the empirical evidence on whether this activity affects firm performance. A small
number of American institutional investors, mostly public pension plans, spend a trivial
amount of money on overt activism efforts. They don't conduct proxy fights, and rarely try
to elect their own candidates to the board of directors. Legal rules, agency costs within
the institutions, information costs, collective action problems, and limited institutional
competence are all plausible partial explanations for this relative lack of activity. The
currently available evidence, taken as a whole, is consistent with the proposition that
the institutions achieve the effects on firm performance that one might expect from this
level of effort -- namely, not much.
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Working Paper # 128
German Codetermination and German Securities Markets
Columbia Law Review, Vol. 98, No.1, pp. 167-183, 1998
Germany lacks good securities markets. Initial public offers are infrequent, securities trading is shallow, and even large public firms typically have big blockholders that make the big firms resemble "semi-private" companies. These "private" firm characteristics of German ownership are often attributed to poor legal protection of minority stockholders, to the lack of an equity-owning and entrepreneurial culture, and to permissive rules that allow big banks and bank blockholding in ways barred in the U.S.
Here, I sketch out another explanation. German codetermination (by which employees control half of the seats on the German supervisory board) undermines diffuse ownership. First, stockholders may want the firm's governing institutions to have a blockholding "balance of power," a balance that, because half the supervisory board represents employees, diffusely owned firms may be unable to create.
Second, managers and stockholders sapped the supervisory board of power (or, more
accurately, stopped it from developing power). Board meetings are infrequent, information
flow to the board is poor, and the board is often too big and unwieldy to be effective.
Instead of boardroom governance, out-of-the-boardroom shareholder caucuses and meetings
between managers and large shareholders substitute for effective boardroom action. But,
because diffuse stockholders will at key points in a firm's future need a plausible board
(due to a succession crisis, a production downfall, or a technological challenge), diffuse
ownership for the German firm would deny the firm both boardroom and blockholder
governance. Blockholder governance would be gone (if the block dissipated into a diffuse
securities market) and board-level governance would be unavailable because the
shareholders and managers had weakened the board beforehand. Stockholders would face a
choice of charging up the board (and hence further empowering its employee-half) or of
living with sub-standard (by current world criteria) boardroom governance. In the face of
such choices, German firms (i.e., their managers and blockholders) retain their
"semi-private," blockholding structure, and German securities markets do not
develop.
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Working Paper # 127
Backlash
Columbia Law Review, Vol. 98, No. 1, pp. 217-241, 1998
Economic systems produce wealth; law and economics analysts try to find which laws are more likely to produce more wealth, often with an eye on whether that wealth is distributed acceptably. But for some economic systems, politics may lash back at the productive arrangements and this backlash potential complicates economic analysis. I analyze this problem first abstractly, showing how even a wealthy but Rawlsian fair system could deteriorate due to backlash, with markets unable to remedy the problem. Next I show some plausible national instances that fit the abstract model of wealth, fairness, and political backlash that led to instability, turmoil, and lower wealth.
When the potential for wealth-decreasing instability is high, basic efficiency analysis becomes harder than it would otherwise be. For analyses of American institutions, this "backlash awareness" at first seems irrelevant, because the U.S. has rarely faced economic-based turmoil. Analysts and academics in Europe, Asia and elsewhere, where economic turmoil has been historically real, often seem to American academics to be much more sensitive to the potential effects on stability and backlash of laws. The fact that for most of American history, and certainly for the American present, the turmoil risks of this or that rule have been trivial, helps to explain the American-centered nature of law and economics. But even for the U.S., some institutions, difficult to justify on normal efficiency grounds, become understandable either as institutions that mitigated backlash or that resulted from backlash.
I offer several categories in which the usual mode of law and economics
analysis—ignoring both backlash effects and instability potential—makes sense in
the U.S. I then argue, though, that several American business laws and institutions
(including Glass-Steagall, Robinson-Patman, the late 1980's anti-takeover laws, and
chapter 11 of the Bankruptcy Code) could be seen as backlash, or as the results of efforts
to reduce backlash. In these instances, backlash cannot be ignored in a full analysis of
the laws.
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March 5, 1998
Columbia Law Review, Vol. 99, p. 508-, 1999
In Germany and Japan, large firms' relationships with employees differ from those prevailing in large American firms. Large Japanese firms guarantee many employees lifetime employment and their boards consist of insider-employees. In Germany, employees or their representatives hold half of the seats of the supervisory board. Neither relationship is common in the United States.
These foreign differences, especially Japanese lifetime employment, are said to yield distinctive advantages, most significantly in encouraging firms and employees to invest in human capital. We examine the reported benefits but conclude that lifetime employment is no more than peripheral to human capital investments. Rather, the "dark" side of Japanese labor practice—constricting the external labor market—likely yielded the reported human capital benefits, not the "bright" side of secure employment.
What then explains lifetime employment in Japan, which developed during a time of labor surplus following World War II? We hypothesize two political explanations, one "macro" and one "micro." The "macro" hypothesis is that a coalition of conservative and managerial interests sought lifetime employment to reduce the chances of socialist electoral victories. The "micro" hypothesis is that managers tried to defeat hostile unions and win back factories from worker occupation, firm-by-firm, by offering lifetime employment to a core of workers. Both the "macro" and "micro" goals were not to improve human capital training, but to reduce worker influence, either in elections or in the factory. We assess the evidence for these hypotheses.
We look at Japanese labor practices and related corporate governance institutions as
"path dependent:" A political decision "fixes" one institution and
then the system evolves with that fixed institution by developing efficient complementary
institutions.
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Working Paper # 125
Comparative Corporate Governance
Palgrave Dictionary of Law and Economics
This entry for the Palgrave dictionary looks at the recent literature on comparative
corporate governance. I examine reasons for the upswing in interest in comparative
corporate governance, what the principal national differences seem to be, how different
nations pursue different purposes through their corporate governance systems, and what we
might learn (and already have learned) about structure, political differences, and
convergence in corporate governance systems. I conclude by mentioning some potential
pitfalls in comparative scholarship, such as selection bias, inattention to
complementarities, and ad hoc comparisons, and I briefly suggest a research agenda.
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Columbia Law Review, Vol. 97, No. 5, pp. 1519-1566, 1997
The "New Economic Order" in the United States is a regime of trade
liberalization, a robust market in corporate control, and labor market flexibility. Among
the consequences over the 1980-1995 period is a divergence between the growth rate of
corporate profits and stocks prices, which have increased by approximately 250% in real
terms, and wages, which have barely increased at all, except for the top quintile.
Contrary to popular belief, employees have not significantly participated through their
pension funds in this stock market appreciation. In the historically dominant defined
benefit pension plan, the sponsoring firm, not the employee, is the residual claimant.
Although employees are residual claimants of defined contribution plans, these funds have
been underinvested in equity. In part this is because employees fear the volatility of
equity returns. The article proposes a new capital market instrument, a "pension
equity collar," that would take advantage of the longterm nature of pension fund
investing to provide a guarantee of a minimum return close to the longterm average equity
return in exchange for giving up (or sharing) the upside above the longterm average. Such
an instrument could encourage greater employee equity investment and thus widen the
distribution of the benefits of the New Economic Order. The article proposes that the U.S.
Department of Labor initiate a rulingmaking project under Section 404(c) of ERISA to
determine if such an instrument should be among the menu of choices provided to employees
in defined contribution plans.
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Working Paper # 123
This paper summarizes the law and economics approach to central theoretical questions
in Contract Law and briefly contrasts this approach with noneconomic approaches. The paper
also makes two claims. First, the law and economics approach has considerable explanatory
and justificatory power but has not developed satisfactory rules to govern parties who
contract under conditions of asymmetric information. Second, the law and economics
approach nevertheless is superior to non economic approaches. These latter approaches,
properly understood, ask questions as the law and economics approach, such as what
contract terms would best facilitate long term contracting. The law and economics approach
gives better answers to these questions, by and large, because it has better tools with
which to answer them.
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Working Paper # 122
We consider legal rules that determine the price at which minority shareholders can be
excluded from the corporate enterprise after a change in control. These reles affect
investment after such a change as well as the probability of the change itself. Our
principal results are that minority shareholders should be given the falue that their
interest would have had were no later investment made; and that this rule is best
implemented, in large companies, by awarding the minority the pre-investment market value
of their shares. The former aspect of our proposal is consistent with much current law but
is rejected by many modern law reformers; the latter aspect of our proposal is novel.
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Working Paper # 121
Intelligible Differences: On Deliberate Strategy and the Exploration of Possibility
in Economic Life
October 1995
No Abstract Available
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Working Paper # 120
Design, Deliberation and Democracy
December 1995
No Abstract Available
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Working Paper # 119
Published in The American Corporation Today, Carl Kasen, Ed. Oxford Press, Chap. 4, pp. 102-127, 1996
In this essay, prepared for The Corporation and Modern Society: A Second Look (forthcoming, Carl Kaysen, ed.), I analyzed changes in law's impact on the corporation during the past thirty-five years, what the underlying bases for these changes might have been, and how these changes affected corporate law.
When the first The Corporation and Modern Society symposium was held in 1959, today's issues, such as competitiveness, were hardly apparent, and the issue of collossal corporate power was paramount. Antitrust law in particular was seen to be a means to restrain the large corporation.
Underlying the 1959 urge to tame the large corporation was the widespread existence (or at least perception) of industrial oligopoly. It was oligopoly (or perhaps really the superior efficiency of a few American manufacturing leaders) that gave the large firm slack and induced the widespread perception of its power.
What erased that image of power in the ensuing decades is clear: The reconstruction of Europe and Japan forced the American manufacturing oligopolists to compete in the international arena; an accelerating pace of technological change made old structures obsolete and brought forth new domestic competitors. While many of the old industrial firms were, or became, fit to compete in new international arena and to ride the waves of new technological change, some weren't. Even the fit ones have to sweat to survive and cannot relax as they did four decades ago, making competivieness considerations overshadow those of corporate power.
Globalization changed the 1959 attitudes and shifted the legal focus on the
corporation. Antitrust attacks to break up the giants seemed politically sensible when the
three oligopolists split the U.S., and sometimes the world, market. They made no sense
when the three came to be embedded in a world-wide market of ten firms. Antitrust rules
relaxed. The notion of using law to control corporate power faded, and the legal questions
began to focus on whether law plays some role in hindering, or enhancing corporate
competitiveness.
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Working Paper # 118
Published in Harvard Law Review, Vol. 109, No. 3, pp. 641-668, January 1996
In this essay, I refine the classical evolutionary model from law and economics by
modifying it to accommodate three related concepts, one from chaos theory, another of path
dependence, and a final one from modern evolutionary theory itself. The goals for the
essay is to provide us a richer understanding of what makes legal and business
institutions.
This paper is available though the Harvard Law Review
http://www.harvardlawreview.org/Publications.html
Working Paper # 117
This paper argues against the view, widely held among economists, that markets
presuppose clearly defined, well enforced property rights and rules of contract.
Sophisticated property and contract rights necessary for a modern market economy
presuppose the existence of complex institutions that cannot be established independently
of the market itself. Moreover, such institutions often develop not because of any actions
of the state, but as a spontaneous response to market demand. The paper sketches a
theoretical position and illustrated the process of the creation of property rights with
the help of an analysis of recent developments in Eastern Europe.
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Working Paper # 116
Corporate Governance in Central Europe and Russia, Roman Frydman,
Cheryl W. Gray, and Andrzej Rapaczynski, Eds.,
World Bank/CEU Press, Vol. 1, Chap. 5, pp. 187-241, 1996
The paper is based on a survey of 148 Russian privatization investment funds (PIFs) representing, in terms of size, 69 percent of the population of all PIFs created in connecting with the voucher privatization of ca. 14,000 state enterprises. The PIFs surveyed hold shares in some 4 to 5 thousand privatized enterprises, thus providing a window into the world of corporate governance of a substantial portion of Russian firms.
The paper argues that PIFs, like most other outside investors, have relatively small impact on the governance of Russian firms due to the firms' domination by corporate insiders, particularly management. Given high returns from sharel\holder activism, the PIFs attempt to influence the firms in their portfolios in a variety of ways (through obtaining board seats and providing them with a range of services), but have extremely poor access to information and are largely unable to prod the firms toward more radical restructuring. In particular, the PIFs are only rarely able to effect managerial changes, although a logistic equation model used shows that firms which do participate in more that one dismissal of top managerial personnel seem to be interested in fundamental trdytuvyutinh.
The paper also describes tha main features of the emerging capital market and analyzes
the determinants of the trading acitivity of the PIFs.
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Working Paper # 115
October 15, 1995
This paper, which is in the form of a very preliminary draft, addresses the issue of
linking international trade law to other issues, such as the environment, workers' rights,
and human rights. This draft attempts to establish a basic analytical framework for the
international linkage of issues, primarily addressing two questions. The first is the
nature of the claim that some issue or regime should be linked to trade policy. The second
is the various ways in which issues or regimes can be linked to trade in the mutilateral
context. The basic thesis of the paper is that conflict over the substantive issue of
linkage has to some extent been misplaced. Rather, we should focus attention instead on
the most appropriate means of linkage. (This paper can be profitably read in conjunction
with the author's paper, "Lying Down with Procrustes: An Analysis of Harmonization
Claims," which is now available in page proofs.)
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Working Paper # 114
October 30, 1995
This paper, which is part of a larger global project edited by John Jackson and Alan
Sykes, describes in some detail the implementation of the Uruguay Round trade agreements
in the United States. The emphasis is on the legislative process and legal implementation,
and in particular the status of the agreements and dispute settlement rulings in United
States law. Background is also provided on the President's negotiating authority and the
fast track procedure. Issues of sovereignty and federalism are also briefly discussed. The
paper is primarily descriptive, and does not contain an economic analysis of the Uruguay
Round agreements or the United States' implementation. Its primary purpose is to provide
an overview of the implementation in the United States, and a basis for comparison with
other jurisdictions.
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Working Paper # 113
Published in Washington University Law Quarterly, Vol. 74, No. 2, pp. 327-345, 1996
Corporate governance attracted attention beyond the realm of lawyers and quite specific
legal rules because of the growing perception that a link existed between corporate
governance and corporate performance: better governance, the hypothesis goes, yields more
efficient production. The potential link between governance and institutions was given
saliency by the large institutional differences between the corporate governance systems
of the three most successful industrial economies: Germany's universal bank centered
system; Japan's main bank/cross holdings centered system; and the United State's stock
market centered system. This paper examines the hypothesized link between corporate
governance and economic efficiency through two lenses that highlight the role of national
institutions: path dependency and industrial organization. The goal is a clearer
understanding of the role of corporate governance institutions as vehicles of adaptive
efficiency.
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Working Paper # 112
December 1996 (Updated in working paper # 143)
A common corporate governance strategy followed by institutional investors is to press
for boards of directors of public companies to contain primarily independent directors. We
conduct the first large sample, long-horizon study of whether adding independent directors
to boards of directors affects performance. We find little evidence that adding
independent directors affects firm performance, across a wide variety of performance
measures. Firms with more independent directors grow more slowly than other firms, but the
causation seems to run from slower growth to a higher proportion of independent directors,
rather than the other way around. There is modest evidence that adding inside directors is
correlated with improved performance, up to about 40% inside directors. We conclude that
the current push for greater independence of directors lacks empirical support.
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Working Paper # 111
Published in Fair Trade and Harmonization, J. Bhagwati, and R. Hudec, MIT Press, 1996
Recently, claims for harmonization of national laws and policies have been closely linked to claims for "fair trade". The scholarly literature has begun to embrace the notion that harmonization is the mechanism by which unfair differences in legal and other regimes are eliminated, and the "level playing field" is restored. The "fair trade" idea is undoubtedly one source of harmonization claims, but it would be misleading to characterize harmonization claims generally in this way. The purpose of this paper is to elaborate a more or less complete set of justifications for harmonization efforts, and to evaluate those claims in the context of the international trading system. The focus is on truly "international" harmonization among independent nations sharing no common political or economic authority. Some of the issues raised by international harmonization are familiar from discussions of federalism or "subsidiarity", but the context of claims for international harmonization, and the process for its realization, are substantially different.
This paper considers harmonization from a theoretical, and somewhat abstract, perspective. It addresses in this context the following questions regarding harmonization claims: What do we mean by "harmonization"? What are the justifications for the claim that the laws of two or more jurisdictions should be the same? Why do laws and regulatory policies differ in the first place, and do the reasons for difference suggest additional costs to the process of harmonization? What other costs might harmonization entail? What kind of harmonization is needed and to what degree must the laws be harmonized? What should the scope of the harmonization effort be in order to realize any goals without unnecessary costs or distortions? Are there alternatives to harmonization that might serve the goals of harmonization without entailing some of its costs?
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Working Paper # 110
This paper explores the meaning and application of the most-favored-nation obligation
in international trade relations. In focusing on the MFN obligation contained in the
General Agreement on Tariffs and Trade, it considers how the obligation in a multilateral
context differs from the historical use in bilateral agreements. The paper further
analyzes the concept of "like products" used to determine the existence of
discrimination. Economic economic concepts, such as cross-elasticity of supply and demand,
are considered, but they seem to only partially capture the proper legal application of
the MFN obligation. The paper concludes, based on analysis and some historical evidence,
that the notion of like products is context sensitive, and differs substantially in
accordance with the regulatory purpose asserted.
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Working Paper # 109
Eminent Domain and Land: A Rationale of the Law of Takings
Published in Hofstra Law Review, Vol. 24, No. 1, pp. 1-, 1995
When does government action so adversely affect private property in land as to constitute a "taking," thereby triggering the constitutional requirement of just compensation? The answer to this question depends on the answers to three subsidiary questions: (1) Does the government's action expose risk-averse owners to substantial uninsurable losses? (2) Will the action impede economic progress by discouraging work and saving and investment? (3) Does the government's action seek to obtain public benefits at private expense in circumstances in which taxpayers would not have expended public funds to obtain the same benefits (despite the administrative feasibility of doing so)?
This analytical model is applied to fou
r categories of cases: (1) governmentally sanctioned intrusions on private property;
(2) government operations that physically interfere with the use and enjoyment of land
(despite the absence of an intrusion); (3) government restrictions on the use of land,
including abatements of "harmful" activities, zoning, environmental regulations,
and landmark preservation; and (4) rent control.
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Working Paper # 108
The Gold Ring Problem
Published in University of Toronto Law Journal, pp. 469-494, 1997
The holder of an asset, uncertain of its value, is concerned about how (and by whom) information about the potential value should be produced. Since information is both costly to produce and potentially valuable, the owners have some incentive to economize whether they bear the costs directly or indirectly (with the direct incidence on buyers and potential buyers). Could a baseline rule—voluntary disclosure and private ownership of the information—be improved upon by either compelling production and disclosure of information or by restricting the owner's right to exclude? Because there is already a large literature on compulsory disclosure, this paper addresses only the no-exclusion issue. Specifically, it critically reviews two previous efforts, one by Posner (emphasizing the relative risk aversion of the owner and others), and the other by French and McCormick (who argue that the owners always bear all the costs).
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Working Paper # 107
Published in Coasean Economics: Law and Economics and the New Economics, Steven G. Medema, ed., pp. 95-103, 1997
In the third of a century since the appearance of "The Problem of Social
Cost" much has been written on the efficiency properties of tort remedies. This paper
examines two instances in which contracting around default tort rules would have been
possible. In the first instance—Coase's railroad spark problem—parties contract
around a tort rule which appeared to be efficient. In the second—measurement errors
by surveyors of quantity and quality in international petroleum product
transactions—parties fail to contract around a tort rule which appeared inefficient.
In both instances arguments reconciling the apparently anomalous behavior with economic
theory are proffered, albeit with little confidence.
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Institutional Investors in Transitional Economics: Lessons from the Czech Experience
John C. Coffee, Jr.
Corporate Governance in Central Europe and Russia, Roman
Frydman, Cheryl W. Gray, and Andrzej Rapaczynski, Eds.,
World Bank/CEU Press, Vol. 1, Chap. 4, pp. 111-186, 1996
and
Comparative Corporate Governance - The State of the
Art and Emerging Research,
Edited by K.J. Hopt, H. Kanda, M.J. Roe, E. Wymeersch and S. Prigge Oxford University
Press 1998
No Abstract Available
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Competition Versus Consolidation:
The Significance of Organizational Structure in Financial and Securities Regulation
John C. Coffee, Jr.
Published in The Business Lawyer, 1995
No Abstract Available
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Working Paper # 104
Corporate Law From Scratch
Bernard S. Black, Reinier H. Kraakman and Jonathan Hay
Corporate Governance in Central Europe and Russia, Roman
Frydman, Cheryl W. Gray, and Andrzej Rapaczynski, Eds.,
World Bank/CEU Press, Vol. 2, Chap. 7, pp. 245-302, 1996
This paper develops an approach to drafting corporate law for emerging
capitalist economies that is based on the case study of a model statute recently completed
for the Russian Federation. The paper describes the contextual features of emerging
economies that make the import of statutes from developed countries inappropriate,
including the prevalence of controlled companies and the weakness of private
institutional, market, cultural, and legal enforcement. Against this backdrop, we argue
that the best legal strategy for giving necessary protection to outside investors in
emerging economies while simultaneously preserving the discretion of companies to invest
is a "self-enforcing" model of corporate law. Unlike the "prohibitive"
corporate law that characterized developed economies in earlier periods, self-enforcing
law does not regulate or prohibit substantive corporate decisions. Instead, it tightly
structures decision- making processes in the company to allow outside shareholders to
protect themselves from insider opportunism with minimal resort to legal authority
including the courts. Among the many examples of self-regulatory statutory provisions are
a mandatory cumulative voting rule for the selection of directors, which assures board
representation to minority blockholders in controlled companies, and dual shareholder- and
board-level approval procedures for self- interested transactions. In addition to
reviewing such specific statutory provisions, the paper addresses the issues of inducing
voluntary compliance and structuring remedies in emerging economies, as well as the
drafting challenges posed by special classed of investors such as employee-shareholders
and state shareholdings. We conclude by examining the implications of the self-regulatory
model of corporate law for the on-going debate over the efficiency of corporate law in
developed economies -- and particularly in the United States.
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