“I am very sorry to report that your Social Security number was among the 28,600 illegally retrieved. This does not mean that you are the victim of identity theft or that we have evidence of your Social Security number being misused. And it is important to know that the database does not include banking or credit card information or driver’s license numbers.” Sweet.
Archive for January, 2007
Becker and Posner on "Libertarian Paternalism"
Posted by Josh Wright on January 15, 2007
Becker and Posner take on “libertarian paternalism” this week. The entries are both worth reading, especially for the parts where these co-bloggers disagree. Here are my favorite passages from each. First, Posner attempts to distinguish his previous defense of the NYC trans-fat ban from good old-fashioned paternalism:
It might seem that the good could be produced just by competition-impelled advertising by restaurants that do not use trans fats. But such a suggestion ignores the difference between disseminating and absorbing information. If you have a peanut allergy, and the label on a package of cake mix says that the mix contains peanut oil, you know not to buy it; the cost of absorbing the information on the label is trivial. But if you are told that a restaurant does not use trans fats in its meals, determining the significance of that information to you would require you to undertake a substantial research project. You would have to learn about trans fats, somehow estimate the total amount of trans fats that you consume every year, estimate the amount of trans fats in the restaurant meals you consume relative to your total consumption of trans fats, and assess the significance of that consumption in relation to other risk factors that you have or don’t have for heart disease. Few people have the time for such research, or the background knowledge that would enable them to conduct it competently. Given that trans fats have close substitutes in both taste and cost, it is not unrealistic to suppose that the vast majority of people would if consulted delegate to government the decision whether to ban trans fats.
A few thoughts about this distinction. I don’t find it too persuasive because it proves too much. The “consumer ignornance” argument Posner offers goes something like the following. Consumers do not value the disclosure sufficiently because the cost of absorbing the information (in terms of time, calculation, estimation, etc.) is prohibitive. Because of the these costs, which appear to boil down to the complexity of the calculation involved, we cannot trust competition to generate the optimal level of trans-fats consumption.
But doesn’t this argument apply to all sorts of transactions? Is the literature on trans-fats and their long-term health effects all that different on these grounds from smoking, wine, red meat, soda, coffee, potato chips, or credit cards (and credit card consumers appear to be behaving quite rationally in their own interest)? The food items are not types where the costs of absorbing the information is “trivial” like the peanut oil label for the consumer with a peanut allergy. Instead, consumers frequently make tradeoffs associated with long-term health effects that appear to be quite complicated. And the rush of producers going trans-fat free without government intervention suggests at least that consumers are indeed responding to evidence of the harm from trans-fats. Becker’s response to Posner’s previous trans-fat post also contains citations to a literature suggesting that consumers respond rapidly to health news.
And from Becker:
Classical arguments for libertarianism do not assume that adults never make mistakes, always know their interests, or even are able always to act on their interests when they know them. Rather, it assumes that adults very typically know their own interests better than government officials, professors, or anyone else–I will come back to this. In addition, the classical libertarian case partly rests on a presumption that being able to make mistakes through having the right to make one’s own choices leads in the long run to more self-reliant, competent, and independent individuals. It has been observed, for example, that prisoners often lose the ability to make choices for themselves after spending many years in prison where life is rigidly regulated.
The more times this point is made the better. It is not enough to justify paternalistic intervention (soft, hard, libertarian, or otherwise) simply to show that consumers make mistakes. The burden of proof is to demonstrate that the government can make better choices for the individual than can the individual. In accounting for the long run costs of paternalism, we must also be mindful of dynamic effects that are likely to follow from paternalistic decision-making before intervening (on this last point, see Klick and Mitchell in the Minnesota L. Rev., or more recently Ed Glaeser’s essay on Paternalism and Psychology).
Posted in economics, law and economics, markets, regulation | 4 Comments »
Revisiting Two Classics as the New Semester Begins
Posted by Thom Lambert on January 14, 2007
Last Friday was the first day of my Business Organizations class. We began with two articles that have profoundly influenced my thinking about the world in general and the business world in particular. To inaugurate the new semester, I thought I’d take a moment and pay tribute to the insights in those articles (and solicit first day ideas from other business law profs!).
The first piece is F.A. Hayek’s The Use of Knowledge in Society. The article, written at a time when socialism was all the rage among the intelligentsia, pointed out the fundamental flaw in the socialist system. The problem Hayek highlighted was not the much-discussed motivational problem (i.e., why create wealth when the government is going to take it from you and give it to someone else?) but was instead an informational problem: how can economic planners allocate resources to their highest and best uses, and thereby maximize wealth, when the planners are not privy to the time- and space-specific information that determines what those uses are? In Hayek’s words:
The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. The economic problem of society is thus not merely a problem of how to allocate “given†resources — if “given†is taken to mean given to a single mind which deliberately solves the problem set by these “data.†It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality.
The solution to this problem, Hayek argued, is the price mechanism, which he dubbed a “marvel.” Indeed it is. Market prices incorporate gobs of information and quickly process it to produce a single metric that tells consumers and producers precisely what they need to know: whether they should increase their production/consumption or cut back on it.
Suppose, for example, that you own an oil well and can select the level at which you produce oil. You pick up the morning newspaper and read four headlines: (1) “Unrest Worsens in the Middle East”; (2) “Huge Oil Reserve Discovered Off Coast of New Jersey”; (3) “New Senate Leadership Refuses to Budge on ANWR Drilling”; and (4) “GM Announces Plans to Switch Production from SUVs to Hybrids.” What should you do??? Well, headlines (1) and (3) would suggest that oil supplies are going to be tightening, so you should increase production; headlines (2) and (4) suggest just the opposite. What you really need to know is the expected magnitude of each of these effects (and all the others related to oil supply and demand). Fortunately for you, though, you need not spend all day scouring the newswires for oil-related information and estimating the significance of each datum. All you need to do is look at the price of oil, which tells you the best guess of millions of folks about whether or not we need more oil. This is utterly amazing. In Hayek’s words:
The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information is passed on and passed on only to those concerned. … The marvel is that in a case like that of a scarcity of one raw material, without an order being issued, without more than perhaps a handful of people knowing the cause, tens of thousands of people whose identity could not be ascertained by months of investigation, are made to use the material or its products more sparingly; that is, they move in the right direction. … I have deliberately used the word “marvel†to shock the reader out of the complacency with which we often take the working of this mechanism for granted. I am convinced that if it were the result of deliberate human design, and if the people guided by the price changes understood that their decisions have significance far beyond their immediate aim, this mechanism would have been acclaimed as one of the greatest triumphs of the human mind.
The bottom line for Hayek, then, is that resources are most efficiently allocated not by centralized planners but by the “man on the spot” responding to the information inherent in market prices.
Enter Professor Coase. In The Nature of the Firm, he observed that this is absolutely not what we see in business organizations: “Outside the firm, price movements direct production, which is coordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur/coordinator, who directs production.” Thus, “the distinguishing mark of the firm is the supersession of the price mechanism.” Business organizations are, in short, little islands of socialism in which Hayek’s beloved price mechanism is “superseded.”
So why do these “islands of conscious power” emerge? Because there are costs to using the market to allocate resources — most notably, transactions costs. Suppose, for example, that you want to start a catering business. You could minimize your labor costs by going down to the unemployment office every day and hiring, for the day, the laborers you’d need to fill that day’s orders. By taking that tack, you could pay the lowest wages possible (since your workers’ next best option would be unemployment), and you could ensure that you didn’t have any idle laborers (since you could hire only as many folks as you’d need to fill that day’s orders). But of course you wouldn’t do that because it would be extremely costly to engage in this process day after day. Instead, you’d hire some folks for the long term, accepting the possibility that you’ll probably have some periods of employee idleness. Business organizations emerge, then, as means of economizing on transactions costs. They will grow until the degree to which they reduce transactions costs is exceeded by the efficiency losses they create (e.g., the costs of idle resources, the agency costs that inevitably result when managers command resources they do not own).
This conception of the firm as a construction designed to minimize costs has profound implications for the law of business organizations. It also shows us how transactional lawyers can create wealth (as opposed to merely redistributing it, as lawyers often do). If the nature of the firm is as Coase describes, then the law should treat business organizations as no more than cost-minimizing nexuses of contracts between the suppliers of capital, managerial talent, and labor. This suggests (1) that the law should provide some “off-the-rack” nexuses of contracts that would appear to reflect the needs of large classes of business entities, and (2) that these various off-the-rack collections of contracts should be freely tailorable by business planners. Transactional lawyers can add value, then, by tailoring these off-the-rack contracts to meet their clients’ specific needs.
[Interestingly, Henry Manne has recently suggested that business planners might want to create Hayekian price mechanisms within the firm in order to enhance the quality of information available to managers. His fascinating short paper Hayek, Virtual Markets, and the Dog that Did Not Bark suggests how planners might choose to authorize insider trading (or internal prediction markets) in order to provide managers with the information-revealing benefit of prices.]
That’s the nutshell version of the first day of my Bus Orgs class. I’d be most interested in hearing what other law profs do to introduce this subject.
Posted in business, contracts, corporate law, economics, insider trading, law and economics, law school, markets | 14 Comments »
Lott v. Levitt: Low Stakes?
Posted by Keith Sharfman on January 12, 2007
Michael Abramowicz over at Concurring Opinions has an interesting post about the ongoing litigation between economists John Lott and Steven Levitt. Lott’s suit alleges that Levitt defamed him in his recent book Freakonomics by suggesting that Lott’s research on the relation between guns and crime could not be “replicated” by other scholars and in a subsequent email to an economist suggesting that Lott had paid $15,000 to the Journal of Law & Economics to publish in a special issue a series of articles supporting Lott’s views on guns. This week, a federal district court in Chicago granted Levitt’s motion to dismiss the claim concerning the statement in Freakonomics but denied his motion to dismiss the claim concerning the email.
Abramowicz suggests in his post that Lott’s “potential damages are almost certainly low” and that this case “though not technically frivolous” is “of a type that our legal system does not handle well” and “a vexatious use of the legal system, because the cost of bringing the claim seems much larger than any plausible reputational damage to Lott.”
Leaving the merits of the dispute aside, my question is this: if the cost of bringing the claim is really much larger than any damages that Lott may recover, then why is Lott pursuing the case? Isn’t Lott’s pursuit of the case strong evidence that he believes he could recover more than his costs?
Moreover, if indeed the claim is worth less than the cost of litigating it, why is Levitt vigorously defending the suit? Why have he and HarperCollins (his publisher) spent so much money disputing liability (e.g., by filing the motion to dismiss) rather than simply relaxing, knowing that damages won’t be very high? Isn’t it just as “vexatious” to dispute a vexatious claim as it is to assert one?
The answer, I think, is that defamation suits implicate subjective nonpecuniary interests that are difficult for courts to value. The formal legal remedies available in such cases are thus usually undercompensatory and pale in comparison to the reputational effects of winning or losing. While the financial stakes may be low, more is at stake than simply the money. The case is about reputation, not money. Hence the current legal quagmire. Even a generous financial settlement is therefore not likely to satisfy Mr. Lott, and by the same token an admission of having made a false statement is not something that Mr. Levitt would likely consider offering.
Here’s my suggestion for the most efficient way to end the dispute: in exchange for Lott’s agreement to dismiss the suit with prejudice, Levitt could agree to issue a statement not admitting to having defamed Lott but rather simply saying that he respects John Lott’s intellect and his work as an economist even though he remains skeptical about Lott’s work on guns and crime.
Hopefully a settlement along these lines is in the works, especially now that HarperCollins is out of the case and Levitt will have to start paying his lawyers out of his own pocket. But then again, settlement of the case would deprive bloggers of an interesting topic about which to comment!
Posted in economics, law and economics, scholarship, torts, universities | 1 Comment »
Directors and Time Management
Posted by Elizabeth Nowicki on January 11, 2007
I presented my “Not in Good Faith” paper at Cornell this past fall, and Professor Jeff Rachlinski (behavioral wonk, among other things) asked an interesting question that I would like to mention here. (Let me remind you that my “not in good faith” paper deals with a director’s obligation to act “in good faith.” My general position is that courts have been sloppy in reviewing a director’s alleged failure to act in good faith. Rather than asking the complaining shareholder to show that the director did not do what a director acting “in good faith” would do, the court requires the shareholder to prove affirmative bad faith.)
I note in my paper that I think the directors at the helm of Merck, Tyco, Disney, Enron, etc. when those corporations had their “scandals” were totally qualified, and I do not think that they were acting with evil motives when preventable failings struck their corporate charges. Rather, I take the position that the old-school director, serving on multiple boards in addition to having a “day job,” just does not have the time to do well his job as director. There are only so many hours in the day. I take the position that Disney’s Ovitz compensation fiasco, for example, was caused by a time-pressure oversight gap. The same can be said about many other corporate problems. They are not aleatory; the people at the helms of these boards almost always have “other jobs.”
In my paper, I take the position that “professional directors” – directors who have no job other than to be the director of a given corporation or two – are worth considering. Jeff’s response to that position was something to the effect of “great, let’s take people with no experience and first-hand knowledge and give *them* the senior oversight role of director.” (I mention Jeff’s specific comment because it made me chuckle. Jeff is incredibly witty, and, not surprisingly, his comment was a good one.)
My response to Jeff was that I would rather have some 33 year old Wharton grad who has done a few years of consulting or auditing and would give 65 hours per week to the director job in the director role than a 63 year-old senior executive at some major corporation or the 58 year old Dean of a law school. Those folks just do not have *time* to do a decent job. As studies have shown, there is a point in the work schedule after which one’s effectiveness actually decreases (as opposed to the typical increase in efficiency of the person who has her time tightly booked). I do not want *that* person serving as the ultimate back-stop for my corporation. I would rather resort to “professional directors.” Of course, I am sure the notion of the ”professional director” will not be a big hit. (By the way, I obviously did not coin the phrase “professional director.” I borrowed it from Gilson, Kraakman, and Wells, though I am not sure if they coined the term.)
Jeff posed a great point, and I am not sure that there is a perfect answer, except to admit that I am really just taking the lesser of two evils by resorting to professional directors who might lack industry-specific managerial experience.
Posted in Uncategorized | 1 Comment »
Cluster Hiring in Law Schools?
Posted by Josh Wright on January 9, 2007
This article documents the “cluster hiring” strategy employed by the Duke Economics Department over the past several years (HT: Marginal Revolution). The article defines cluster hiring as: “recruiting groups of researchers who share an approach to an academic discipline and have existing relationships.” Part of the motivation for this hiring strategy was simply to increase the size of the faculty, but Department Chair Thomas Nechyba describes the strategy as part of an “intellectual vision of getting people to come here who otherwise would have never worked together, and who could combine their skills here in a way that creates much more than they individually could have.â€
This is a very interesting approach to faculty hiring, and it certainly makes sense to hire “intellectual couples” (as the article describes pairs that are likely to collaborate) or “trios” in order to take advantage of these complementarities. Being a relatively new law professor, I don’t know whether any law schools have adopted this approach in recent times. GMU’s string of law and economics hires under Henry Manne in the late 1980s certainly qualifies. I can also think of examples of a law school making several excellent hires in one field of expertise simultaneously or over a few years time in order to bolster the school’s presence in that speciality. But cluster hiring as it is described here seems to have the additional dimension of explicitly seeking co-authors, potential co-authors, or colleagues that would produce synergies even if not through co-authorship. Are there historical examples of law schools making “cluster” hires? if so, how’d it work? Is this a good strategy for law schools? Or if this a less feasible strategy for law schools because co-authorship is looked upon, let’s say, less favorably than in other fields?
Posted in law school, legal scholarship, scholarship, universities | 4 Comments »
A Few Things Economics is Good For …
Posted by Josh Wright on January 9, 2007
Professor D’Amato is at it again. And by “it,” I mean making overblown claims that economics is useless (you might recall our last exchange where I responded to his mistaken assertion that economics had not changed antitrust in “any noticeable way”). Here’s his latest from a comment over at Prawfs.
Well, what exactly is economics good for? Certainly not prediction of economic events–the stock market, tomorrow’s value of the dollar, whether recession is coming, whether we’re in a recession right now or not, whether housing sales are going up or down. But if an economist cannot predict anything relating to the market or economic phenomena, then economics is a science without predictive value. But what kind of a science could that possibly be?
Originally, I was tempted to write a long post explaining what is wrong with the view that economics is about predicting events in the sense described above (e.g. what will the S&P 500 close at tomorrow, on January 21, and on June 3rd, 2010), and also offering a list of things “related to the market or economic phenomena” that economists can predict pretty well (Here’s one that comes to mind … or how about what happens when you set the price of kidneys to zero? Or impose rent control? Or what happens to prices when the producers of two complements merge? How about understanding why suppliers granting distributors exclusive territories is likely to increase output? Anyway … )
But I decided against it. Look, these sorts of claims are nothing new. And they really aren’t particularly interesting in their own right. Some folks don’t care for economic analysis for one reason or another. Some have principled objections, some don’t. Some associate economics as a nasty little set of tools that would have us place unseemly monetary values on things as sacred as human kidneys, blood, and human life itself. I’m not very good as blog sarcasm, so just know that the last sentence was written with the appropriate tone. Some think it is a tool of some vast right-wing conspiracy. Others are angry that some economists view what they do as “hard science,” feel like economists overclaim their contribution to policy analysis (which some do, though law professors should not be the first to cast stones on this front), or believe in some permutation or combination of these and other reasons. For that matter, there are even very good economists who don’t like what is being taught in top modern graduate economics departments (mathematical techniques over “real world” economics). Whatever.
But how anyone could argue that economics does not have anything to offer policy analysis is beyond me. Even the most ardent critics of economics typically concede that has made a positive contribution to policy analysis. This particular form of anti-law and economics rhetoric, I had thought, turned passe long ago. At the very minimum, one would think it an uncontroversial proposition that economics offers useful tools for understanding the consequences of laws. Society would be much better off even if lawmakers understood simple economic concepts like: demand curves slope downward, supply curves slope upward, a price cap will likely result in a shortage, etc. Surely, we in the legal academy are interested in understanding the effects of the legal change? It is here that economics can help! Not to mention more generally on increasing our understanding of firm and human conduct relevant to policy analysis. Surely, we in the legal academy are interested in increased knowledge of these phenomenon as well. Maybe D’Amato’s disdain for economic analysis of the law is unique, but I doubt it. This sort of thing certainly does make me wonder how strong the anti-economics sentiment is at most law schools?
So if I find this sort of anti-economics rant boring, why the response? Good question. Other than making the above point concerning what economics has to offer at a very minimum to the analysis of law and legal institutions, and it should be fairly obvious to readers of this blog that I personally believe economics offers much more than just tools to evaluate the consequences of legal change, I wanted to point to an essay by Hal Varian (“What Use is Economic Theory“) that I read while in graduate school in preparation for a dinner-table debate with “hard scientist” siblings about the utility of economics. Here is a snippet from the introduction that gives the general flavor:
No one complains about poetry, music, number theory, or astronomy as being
‘‘useless,’’ but one often hears complaints about economic theory as being overly esoteric. I think that one could argue a reasonable case for economic theory on purely aesthetic grounds. Indeed, when pressed, most economic theorists admit that they do economics because it is fun. But I think purely aesthetic considerations would not provide a complete account of
economic theory. For theory has a role in economics. It is not just an intellectual pursuit for its own sake, but it plays an essential part in economic research. The essential theme of this essay that economics is a policy science and, as such, the contribution of economic theory to economics should be measured on how well economic theory contributes to the understanding and conduct of economic policy.
Posted in economics, law and economics, markets, regulation | 1 Comment »
Henderson on Law School Rankings
Posted by Josh Wright on January 5, 2007
Bill Henderson has a characteristically thoughtful post on the relationship between law school rankings and law student attrition at ELS Blog. Bill provides some evidence, based on research from a paper co-authored with Andy Morriss (Illinois), that 1L attrition increased significantly in response to the 1997 incorporation of bar passage into its placement methodology. Bill’s got some nice looking tables from the paper with his post, so you can head over there to take a look. Perhaps the most interesting finding (in addition to the variation in the change in attrition rates across tiers) is that “other attrition” has increased more than “academic attrition.” Henderson and Morriss’ take on this data?
Andy and I think it is the transfer student gaming strategy. In a nutshell, Elite school A or Tier 1 school B shrinks its 1L class, gets an LSAT boost, and makes up the revenue by admitting more transfer students, whose credentials are irrelevant for U.S. News purposes. **** Andy and I recommend that ALL outcome/placement data be released into the public domain: number of firms interviewing on campus; employment rates by practice setting; salaries by practice setting; MBE scores, controlling for entering credentials. This would at least force law schools to compete on value-added to students, rather than gaming. I wonder if the ABA reads this blog?
Anybody interested in law school rankings should check out the post.
Posted in law school, legal scholarship | Comments Off
Dear Home Depot Board of Directors,
Posted by Elizabeth Nowicki on January 4, 2007
I write regarding the soon-to-be-vacant position of CEO of Home Depot. As I understand it, the position pays well, little is demanded in terms of results, and the exit package is great. I would like to be hired to fill the CEO position. I realize Frank Blake has been tapped as the new CEO, but I would like to think of myself as someone who could fill Nardelli’s shoes for less money than Blake requires.
Alternatively, I would like to be nominated to serve on the Board of Directors of Home Depot. Where else can I find a job where I actually do not need to show up?
Thank you for your attention to these matters. I look forward to working with you (minimally), and I really look forward to collecting a large paycheck from you.
Best regards,
Elizabeth Nowicki, Radical Shareholder Primacist Qua Budding Potential (and cheap)Â CEO
[This is the second time I have reached out to the Home Depot BOD. I am not optimistic that they will be blogging back. Some day I would like to ask Lucien Bebchuk if he really believes the executive pay problem will resolve itself.]
Posted in Uncategorized | 4 Comments »
Manne on Shareholder Democracy
Posted by Josh Wright on January 3, 2007
Henry Manne is back with another article in the WSJ. This time Manne goes toe-to-toe with the “corporate democrats.”
Profs Ribstein (“Shareholder democracy is just one of the burdens that public corporations have to bear these days”) and Bainbridge (“it’s a brilliant spanking of the shareholder activists, which I highly commend to your attention”) have already chimed in on this one. Still, it is worth posting a few key paragraphs:
The hidden agenda of many corporate democrats is even more apparent when they argue that large corporations are indeed like small republics and should, therefore, like all governments, be democratized or constitutionalized. This is usually no more than an assertion that the large size of an otherwise private enterprise is sufficient to convert what would otherwise be a private ordering into something suffused with a public interest — in other words, an argument for more socialism. The very success of a private concern becomes the reason for destroying its privateness — a neat rhetorical trick if it was not so patently absurd.
Sometimes this argument is made a bit more logical by saying that large size necessarily means that external costs will be visited on the rest of society. This is the basis for the currently popular claim that so-called “stakeholders” should have a real voice in how the corporation conducts its affairs. But even if there are occasional costly externalities associated with corporate activities, rearranging corporate governance, which is obviously functioning adequately for investors now, is an irresponsible and costly way to solve that real political problem.
We need corporate activists today more than ever, but we need them to lobby and argue for repeal of our many costly and ill-serving bits of corporate regulation. They might start with Sarbanes-Oxley, then go back in time to cover the Williams Act and state anti-takeover provisions, the Investment Company Act of 1940, the Securities and Exchange Act of 1934 and the Securities Act of 1933. I know this is pie-in-the-sky idealism, but it does not change the fact that, on balance, the world would be a far better place without these laws or anything like them.
I don’t have anything to add to this other than a recommendation to go read it in full.
Posted in corporate governance, corporate law, economics, executive compensation, legal scholarship, private equity, regulation, sarbanes-oxley | Comments Off
