Copyright (c) 2010 NELLCO All rights reserved. http://lsr.nellco.org/harvard_olin Recent documents in Harvard Law School John M. Olin Center for Law, Economics and Business Discussion Paper Series en-us Tue, 09 Nov 2010 14:37:03 PST 3600 http://lsr.nellco.org/harvard_olin/650 http://lsr.nellco.org/harvard_olin/650 Fri, 09 Oct 2009 11:28:23 PDT The socially desirable design of the appeals process is analyzed assuming that it may involve either an initial discretionary review proceeding – under which the appeals court would decide whether to hear an appeal – or else a direct appeal. Using a stylized model, I explain that the appeals process should not be employed when the appellant’s initial likelihood of success falls below a threshold, that discretionary review should be used when the likelihood of success lies in a mid-range, and that direct appeal should be sought when this likelihood is high. Further, I emphasize that appellants should often be able to choose between discretionary review and direct appeal, notably because appellants may beneficially elect discretionary review to save themselves (and the judicial system) expense. This suggests the desirability of a major reform of our appeals process: appellants should be granted the right of discretionary review along with the right that they now possess of direct appeal at the first level of appeals. Steven Shavell http://lsr.nellco.org/harvard_olin/649 http://lsr.nellco.org/harvard_olin/649 Fri, 09 Oct 2009 11:28:21 PDT Treasury Secretary Geithner announced a plan, which the Treasury is willing to finance with up to $1 trillion of public funds, to partner with private capital to buy banks’ “troubled assets.” The Treasury has not yet settled on the plan’s design, and its announcement has encountered substantial skepticism as to whether an effective plan for a public-private partnership in buying troubled assets can be worked out. This paper argues that, yes, it can. The paper also analyzes how the plan should be designed to contribute most to restarting the market for troubled assets at the least cost to taxpayers.The government’s plan should focus on establishing a significant number of competing funds that will be privately managed and dedicated to buying troubled assets – not on creating one, large public-private aggregator bank. Establishing competing funds, I show, is necessary both to securing a well-functioning market for troubled assets and to keeping costs to taxpayers at a minimum.Each new fund will be partly financed with private capital, with the rest coming (say, in the form of non-recourse debt financing) from the government’s Investment Fund planned by the Treasury. One important element of the proposed design is a competitive process in which private managers seeking to establish a fund participating in the program will submit bids as to what fraction of the fund’s capital will be funded privately. The government will set the fraction of each participating fund’s capital that must be financed with private money at the highest level that, given the received bids, will still enable establishing new funds with aggregate capital equal to the program’s target level. Overall, I show that the proposed design will leverage private capital to the fullest extent possible and will provide the most effective and least costly mechanism for restarting the market for troubled assets. Lucian A. Bebchuk http://lsr.nellco.org/harvard_olin/648 http://lsr.nellco.org/harvard_olin/648 Fri, 09 Oct 2009 11:28:19 PDT Fashion is one of the world's most important creative industries. As the most immediate visible marker of self-presentation, fashion creates vocabularies for self-expression that relate individuals to society. Despite being the core of fashion and legally protected in Europe, fashion design lacks protection against copying under U.S. intellectual property law. This Article frames the debate over whether to provide protection to fashion design within a reflection on the cultural dynamics of innovation as a social practice. The desire to be in fashion - most visibly manifested in the practice of dress - captures a significant aspect of social life, characterized by both the pull of continuity with others and the push of innovation toward the new. We explain what is at stake economically and culturally in providing legal protection for original designs, and why a protection against close copies only is the proper way to proceed. We offer a model of fashion consumption and production that emphasizes the complementary roles of individual differentiation and shared participation in trends. Our analysis reveals that the current legal regime, which protects trademarks but not fashion designs from copying, distorts innovation in fashion away from this expressive aspect and toward status and luxury aspects. The dynamics of fashion lend insight into dynamics of innovation more broadly, in areas where consumption is also expressive. We emphasize that the line between close copying and remixing represents an often underappreciated but promising direction for intellectual property today. Jeannie Suk http://lsr.nellco.org/harvard_olin/647 http://lsr.nellco.org/harvard_olin/647 Fri, 09 Oct 2009 11:28:18 PDT Most studies of executive compensation focus on publicly traded companies. The high levels of compensation there are often attributed to agency slack due to ownership by diffused shareholders. If so, pay at private companies more closely held should be much lower. Governments in the United States and elsewhere do not require the pay of executives in private companies to be publicly disclosed, but until 2004 the tax office of Japan published the name and tax liability of any individual paying over about $100,000 in tax. We match this tax data with rosters of some 1,400 presidents of public and 4,100 presidents of private corporations. We find that public and private company presidents have similar incomes. Both groups earn incomes that rise with the size and profitability of the firm, but the presidents’ incomes are more sensitive to profitability at public firms than at private ones. In Japan, at least, public firms pay their presidents no more than private firms do, and tie that compensation more closely to observable performance benchmarks. J. Mark Ramseyer http://lsr.nellco.org/harvard_olin/646 http://lsr.nellco.org/harvard_olin/646 Fri, 09 Oct 2009 11:28:16 PDT Chicago School theorists have argued that tying cannot create anticompetitive effects because there is only a single monopoly profit. Some Harvard School theorists have argued that tying doctrine’s quasi-per se rule is misguided because tying cannot create anticompetitive effects without foreclosing a substantial share of the tied market. This Article shows both positions are mistaken. Even without a substantial foreclosure share, tying by a firm with market power generally increases monopoly profits and harms consumer and total welfare, absent offsetting efficiencies. The quasi-per se rule is thus correct to require tying market power and a lack of offsetting efficiencies, but not a substantial tied foreclosure share. However, the quasi-per se rule should have an exception for products with a fixed ratio that lack separate utility, because those conditions generally negate anticompetitive effects absent a substantial foreclosure share. Cases meeting this exception should instead be governed by a traditional rule of reason that requires a substantial foreclosure share or effect.Bundled discounts can produce the same anticompetitive effects as tying without substantial tied foreclosure, but only when the unbundled price exceeds the but-for price. Thus, when the unbundled price exceeds the but-for price, bundled discounts should be condemned based on market power absent offsetting efficiencies, with the same exception for products with a fixed ratio that lack separate utility. When the unbundled price does not exceed the but-for price, bundled discounts should be condemned only when there is substantial foreclosure or direct proof of anticompetitive effects. Alternative tests for judging bundled discounts, such as comparing the effective price to cost, are not only underinclusive, but perversely exempt the bundled discounts with the worst anticompetitive effects. Einer Elhauge http://lsr.nellco.org/harvard_olin/645 http://lsr.nellco.org/harvard_olin/645 Fri, 09 Oct 2009 11:28:14 PDT The duties owed by independent directors of large corporations to monitor the corporation’s affairs have never had more political salience. Given the Enron-era debacles, the recent meltdown in our nation’s financial sector, the dependence of workers on equity investments to secure their retirements, the globalization of American corporate law principles, and the complexity of managing corporations with international operations, the legal standards used to evaluate whether directors have complied with their fiduciary duties will be a subject of growing international policy interest. This article addresses an important dimension of that issue by examining the role of good faith in corporate law, and its use as the definition of the state of mind with which a director must act to comply with the fiduciary duty of loyalty. In particular, this article employs an historical, etymological, and policy-oriented analysis to address the question of whether the obligation of directors to act in good faith is a separate, free-standing fiduciary duty, or a fundamental aspect of the core duty of loyalty.We conclude, consistent with the Delaware Supreme Court’s recent decision in Stone v. Ritter, that in the American corporate law tradition, the basic definition of the duty of loyalty is the obligation to act in good faith to advance the best interests of the corporation. What this article also shows is that the duty of loyalty has traditionally been conceived of as being much broader than the duty to avoid acting for personal financial advantage. The duty of loyalty also precludes acting for unlawful purposes, and affirmatively requires directors to make a good faith effort to monitor the corporation’s affairs and compliance with law.Finally, we highlight a critical policy implication resulting from Stone v. Ritter, which is that an independent director who is accused of having failed in her monitoring duties may only be held liable if a court finds that she breached her duty of loyalty by consciously failing to make a good faith effort to comply with her duty of care. By requiring a finding of bad faith before imposing liability on an independent director, the corporate law, as explicated by Stone, protects the policy interests underlying the business judgment rule from erosion. Leo E. Strine, Jr. http://lsr.nellco.org/harvard_olin/644 http://lsr.nellco.org/harvard_olin/644 Fri, 09 Oct 2009 11:28:12 PDT There is a widely held view that breach of contract is immoral. I suggest here that breach may often be seen as moral, once one appreciates that contracts are incompletely detailed agreements and that breach may be committed in problematic contingencies that were not explicitly addressed by the governing contracts. In other words, it is a mistake generally to treat a breach as a violation of a promise that was intended to cover the particular contingency that eventuated. Steven Shavell http://lsr.nellco.org/harvard_olin/643 http://lsr.nellco.org/harvard_olin/643 Fri, 09 Oct 2009 11:28:10 PDT The operating agreements of many business ventures include clauses to facilitate the exit of joint owners. In so-called Texas Shootouts, one owner names a single buy-sell price and the other owner is compelled to either buy or sell shares at that named price. Despite their prevalence in real-world contracts, Texas Shootouts are rarely triggered. In our theoretical framework, sole ownership is more efficient than joint ownership. Negotiations are frustrated, however, by the presence of asymmetric information. In equilibrium, owners eschew buy-sell offers in favor of simple offers to buy or to sell shares and bargaining failures arise. Experimental data support these findings. Kathryn E. Spier http://lsr.nellco.org/harvard_olin/642 http://lsr.nellco.org/harvard_olin/642 Fri, 09 Oct 2009 11:28:08 PDT Researchers and shareholder advisers have devoted much attention to developing metrics for assessing the governance of public companies around the world. These important and influential efforts, we argue, suffer from a basic shortcoming. The impact of many key governance arrangements depends considerably on companies’ ownership structure: measures that protect outside investors in a company without a controlling shareholder are often irrelevant or even harmful when it comes to investor protection in companies with a controlling shareholder, and vice versa. Consequently, governance metrics that purport to apply to companies regardless of ownership structure are bound to miss the mark with respect to one or both types of firms. In particular, we show that the influential metrics used extensively by scholars and shareholder advisers to assess governance arrangements around the world—the Corporate Governance Quotient (CGQ), the Anti-Director Rights Index, and the Anti-Self-Dealing Index—are inadequate for this purpose.We argue that, going forward, the quest for global governance standards should be replaced by an effort to develop and implement separate methodologies for assessing governance in companies with and without a controlling shareholder. We also identify the key features that these separate methodologies should include, and discuss how to apply such methodologies in either country-level or firm-level comparisons. Our analysis has wide-ranging implications for corporate-governance research and practice. Lucian A. Bebchuk http://lsr.nellco.org/harvard_olin/641 http://lsr.nellco.org/harvard_olin/641 Fri, 09 Oct 2009 11:28:06 PDT Although administrative law doctrine requires courts to defer to an agency’s reasonable statutory interpretation, the doctrine is unclear as to whether an agency gets less deference when it changes its own prior interpretation. We formally analyze how judicial deference to revised agency interpretations affects those interpretations’ ideological content. We find a non-monotonic relationship between judicial deference to inconsistent agency interpretations and interpretive extremism. This arises because as courts become less deferential to revised interpretations, the initial agency finds a moderate interpretation that will not be revised more appealing. Normatively, our results suggest that an interest in responsiveness of interpretive policy to the preferences of the incumbent leadership favors deference to revised interpretations, while an interest in ideological moderation favors a somewhat less deferential posture to interpretive revisions. Matthew C. Stephenson http://lsr.nellco.org/harvard_olin/640 http://lsr.nellco.org/harvard_olin/640 Fri, 09 Oct 2009 11:28:04 PDT An enduring inquiry for American corporate law scholars is why the small state of Delaware dominates corporate chartering in the United States. Several theories explain the result. I add another partial explanation: size alone makes Delaware attractive to reincorporating firms by making the state’s corporate law more important to the American economy ─ and corporate interest groups ─ than that of other states. Any single state with a small number of incorporations could disrupt their firms’ corporate structures without inducing any repercussions in Washington. But Delaware ─ or really its corporate law ─ is “too big to fail.” Damaged players in other states would be unable to enlist Washington to reverse the result. Nor would the low volume players be wary of Washington’s attention and the possibility of it over-reacting if a major corporate issue reached its agenda. Delaware, though, as home to about half of the American corporate economy, could not seriously disrupt American business without repercussion. Mark Roe http://lsr.nellco.org/harvard_olin/639 http://lsr.nellco.org/harvard_olin/639 Fri, 09 Oct 2009 11:28:03 PDT This paper analyzes how government intervention in the market for banks’ troubled assets is best designed, and also uses this analysis to evaluate the public-private investment program announced by the U.S. government in March 2009. I begin by presenting the case for using government funds to restart the market for troubled assets. I then discuss the advantages of providing government capital to competing privately managed funds, a strategy I have advocated in past work, and I outline the key elements that such a plan should include.Based on this analysis, I propose three improvements to the government’s current plan:• Introducing a competitive mechanism that would ensure that the government’s subsidy to participating private parties is kept at a minimum;• Redesigning the plan to provide such private parties with incentives aligned with those of taxpayers rather than highly skewed incentives to overpay for troubled assets; and• Precluding banks that hold significant amounts of troubled assets from participating as managers or private investors in funds set up under the program.The proposed changes would address most of the concerns that have been raised by critics of the administration’s program. In particular, they would reduce costs to taxpayers, prevent excessive and unnecessary gains by private parties, and produce market prices that can be relied on for valuing assets that remain on banks’ books. Lucian A. Bebchuk http://lsr.nellco.org/harvard_olin/638 http://lsr.nellco.org/harvard_olin/638 Fri, 09 Oct 2009 11:28:01 PDT American corporate law scholars have long focused on state-to-state jurisdictional competition as a powerful engine in the making of American corporate law. Yet much corporate law is made in Washington, D.C. Federal authorities regularly make law governing the American corporation, typically via the securities law—from shareholder voting rules, to boardroom composition, to dual class stock, to Sarbanes-Oxley—and they could do even more. Properly conceived, the United States has two primary corporate lawmaking centers—the states (primarily Delaware) and Washington. We are beginning to better understand how they interact, as complements and substitutes, but the foundational fact of American corporate lawmaking during the past century is that whenever there has been a big issue—the kind of thing that could strongly affect capital costs—Washington acted or considered acting. Here I review the concepts of the vertical interaction, indicate what still needs to be examined, and examine one Washington-Delaware interaction in detail over time. Overall, we cannot understand the governmental structure of American corporate lawmaking well just by examining the nature, strength, and weaknesses of state-to-state jurisdictional competition. Mark Roe http://lsr.nellco.org/harvard_olin/637 http://lsr.nellco.org/harvard_olin/637 Fri, 09 Oct 2009 11:27:59 PDT Ascertaining which enforcement mechanisms work to protect investors has been both a focus of recent work in academic finance and an issue for policy-making at international development agencies. According to recent academic work, private enforcement of investor protection via both disclosure and private liability rules goes hand in hand with financial market development, but public enforcement fails to correlate with financial development and, hence, is unlikely to facilitate it. Our results confirm the disclosure result but reverse the results on both liability standards and public enforcement. We use securities regulators’ resources to proxy for regulatory intensity of the securities regulator. When we do, financial depth regularly, significantly, and robustly correlates with stronger public enforcement. In horse races between these resource-based measures of public enforcement intensity and the most common measures of private enforcement, public enforcement is overall as important as disclosure in explaining financial market outcomes around the world and more important than private liability rules. Hence, policymakers who reject public enforcement as useful for financial market development are ignoring the best currently-available evidence. Mark Roe http://lsr.nellco.org/harvard_olin/636 http://lsr.nellco.org/harvard_olin/636 Fri, 09 Oct 2009 11:27:57 PDT The maxim “divide and conquer” (divide et impera) is invoked frequently in law, history, and politics, but often in a loose or undertheorized way. We suggest that the maxim is a placeholder for a complex of ideas related by a family resemblance, but differing in their details, mechanisms and implications. We provide an analytic taxonomy of divide and conquer mechanisms in the settings of a Stag Hunt Game and an indefinitely-repeated Prisoners’ Dilemma. A number of applications are considered, including labor law, bankruptcy, constitutional design and the separation of powers, imperialism and race relations, international law, litigation and settlement, and antitrust law. Conditions under which divide and conquer strategies reduce or enhance social welfare, and techniques that policy makers can use to combat divide and conquer tactics, are also discussed. Kathryn E. Spier http://lsr.nellco.org/harvard_olin/635 http://lsr.nellco.org/harvard_olin/635 Fri, 09 Oct 2009 11:27:56 PDT This paper addresses one of the key issues – the foreseeability of the housing market downturn that began in September of 2007 and intensified in the fourth quarter of 2007 – that must be addressed in assessing the extensive securities class action litigation that has been filed against financial institutions (and others) seeking to recover damages for investor losses arising out of the credit market crisis. We begin our analysis of this issue by first discussing the legal centrality of this issue to much of this litigation. We then turn to answer the question of when the housing market downturn became foreseeable by analyzing housing prices (regional and nationwide), housing sales, housing future contracts, and various market spreads such as the ABX triple A indexes. We conclude that these data are consistent with the view that the housing market downturn was in fact not foreseen by the market prior to the fourth quarter of 2007. Allen Ferrell http://lsr.nellco.org/harvard_olin/634 http://lsr.nellco.org/harvard_olin/634 Fri, 09 Oct 2009 11:27:54 PDT This paper contributes to understanding the role of executive compensation as a possible cause of the current financial crisis, to assessing current legislative and regulatory attempts to discourage bank executives from taking excessive risks, and to identifying how bankers’ pay should be reformed and regulated going forward.Although there is now wide recognition that bank executives’ decisions might have been distorted by the short-term focus of pay packages, we identify a separate and critical distortion that has received little attention. Because bank executives have been paid with shares in bank holding companies or options on such shares, and both banks and bank holding companies issued much debt to bondholders, executives’ payoffs have been tied to highly levered bets on the value of the capital that banks have. These highly levered structures gave executives powerful incentives to under-weight downside risks.We show that current legislative and regulatory attempts to discourage bank executives from taking excessive risks fail to address this identified distortion. In particular, recently adopted requirements aimed at aligning the interests of executives tightly with those of the common shareholders of bank holding companies – through emphasizing awards of restricted shares in these companies and introducing “say on pay” votes by these shareholders – miss the mark. The common shareholders of bank holding companies, especially now that the value of their investment has decreased considerably, would favor much more risk-taking than would be in the interest of the government as preferred shareholder and guarantor of some of the bank’s obligations.Finally, having identified the problems with current legislative and regulatory attempts, we analyze how best to implement recent legislative mandates that require banks receiving TARP funding to eliminate incentives to take excessive risks. Beyond banks receiving governmental support, we put forward a new strategy for banking regulation; we argue that monitoring and regulating bankers’ pay should be an important element of banking regulation in general, and we analyze how banking regulators should assess and regulate bankers’ pay. Lucian A. Bebchuk http://lsr.nellco.org/harvard_olin/633 http://lsr.nellco.org/harvard_olin/633 Fri, 09 Oct 2009 11:27:52 PDT A system effect arises when the properties of an aggregate differ from the properties of its members, taken one by one. The failure to recognize system effects leads to fallacies of division and composition, in which the analyst mistakenly assumes that what is true of the aggregate must also be true of the members, or that what is true of the members must also be true of the aggregate. Examples are (1) the fallacious assumption that if the overall constitutional order is to be democratic, each of its component institutions must be democratic, taken one by one; (2) the fallacious assumption that if judges are politically biased, courts will issue politically biased rulings. In these cases and many others I will discuss, system effects are an indispensable analytic tool for legal theory. A systemic approach implies that the choices of legal actors are strategically interdependent: the best course of action for any given actor will depend upon what other actors do. Judges deciding how to interpret statutes and the constitution, for example, cannot simply assume, idealistically, that it would be best for them to adopt the approach that would be best for all if adopted by all. If others do not adopt that approach, then the nature of the best approach for the given judge may itself change, taking others’ actions as nonideal constraints. The implication is a second-best approach to constitutionalism and legal interpretation.The judge who takes system effects into account may change her approach in light of the behavior of her colleagues and the behavior of other institutions. Although such a judge is strategic, it does not follow that she is unprincipled. Rather, under identifiable conditions, the systemically-minded judge will be a strategic legalist who attempts to act, within the constraints that arise from others’ behavior, so as to nudge the legal system toward the best possible state, according to her view of the law. Indeed, the systemically-minded judge may even be a legal chameleon who changes her approach as the legal environment, including the behavior of other judges, changes around her, until the court as a whole reaches an equilibrium of optimal diversity. Although such a course of action is psychologically demanding, the systemic benefits that the legal chameleon creates can be attained at the systemic level instead. Wise appointments by Presidents and Senators aiming to diversify the judiciary would mimic, in a second-best way, the diversity that a bench of legal chameleons would produce. Adrian Vermeuele http://lsr.nellco.org/harvard_olin/632 http://lsr.nellco.org/harvard_olin/632 Fri, 09 Oct 2009 11:27:50 PDT This article is the first chapter of the second edition of The Anatomy of Corporate Law: A Comparative and Functional Approach, by Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda and Edward Rock (Oxford University Press, 2009). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. In its second edition, the book has been significantly revised and expanded. As the book's introductory chapter, this article describes the functions and boundaries of corporate law. We first detail the economic importance of the corporate form's hallmark features: legal personality, limited liability, transferable shares, delegated management, and investor ownership. We then identify the major agency problems that attend the corporate form, and that, therefore, corporate law must address: conflicts between managers and shareholders, between controlling and minority shareholders, and between shareholders as a class and non-shareholder constituencies of the firm such as creditors and employees. In our view, corporate law serves in part to accommodate contract and property law to the corporate form and, in substantial part, to address the agency problems that are associated with this form. We next consider the role of law in structuring corporate affairs so as to achieve these goals: whether, and to what extent standard forms - as opposed, on the one hand, to private contract, and on the other, to mandatory rules - are needed, and the role of regulatory competition. Whilst the ‘core’ features of corporate law are present in all - or almost all - legal systems, different systems have made different choices regarding the form and content of many other aspects of their corporate laws. To assist in explaining these, we review a range of forces that shape the development of corporate law, including domestic share ownership patterns. These forces operate differently across countries, implying that in some cases, complementary differences in corporate laws are functional. However, other such differences may be better explained as a response to purely distributional concerns. Reinier Kraakman http://lsr.nellco.org/harvard_olin/631 http://lsr.nellco.org/harvard_olin/631 Fri, 09 Oct 2009 11:27:48 PDT This article is the second chapter of the second edition of "The Anatomy of Corporate Law: A Comparative and Functional Approach," by Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda and Edward Rock (Oxford University Press 2009). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. In its second edition, the book has been significantly revised and expanded. "Agency Problems and Legal Strategies" establishes the analytical framework for the book as a whole. After further elaborating the agency problems that motivate corporate law, this chapter identifies five legal strategies that the law employs to address these problems. Describing these strategies allows us to more accurately map legal similarities and differences across jurisdictions. Some legal strategies are "regulatory" insofar as they directly constrain the actions of corporate actors: for example, a standard of behavior such as a director's duty of loyalty and care. Other legal strategies are "governance-based" insofar as they channel the distribution of power and payoffs within companies to reduce opportunism. For example, the law may accord direct decision rights to a vulnerable corporate constituency, as when it requires shareholder approval of mergers. Alternatively, the law may assign appointment rights over top managers to a vulnerable constituency, as when it accords shareholders - or in some jurisdictions, employees - the power to select corporate directors. We then consider the relationship between different enforcement mechanisms - public agencies, private actors, and gatekeeper control - and the basic legal strategies outlined. We conclude that regulatory strategies require more extensive enforcement mechanisms - in the form of courts and procedural rules - to secure compliance than do governance strategies. However, governance strategies, for efficacy, require shareholders to be relatively concentrated so as to be able to exercise their decisional rights effectively. Reinier Kraakman