A new approach to consumer regulation: firm ownership

Larry Ribstein —  24 October 2011

We have heard a lot about how business exploits consumer biases and therefore we need more regulation and disclosure.  By the time the Consumer Financial Protection Bureau gets up to speed, maybe the regulators will realize their dream of consumers behaving as they should.  In the meantime, Ryan Bubb and Alex Kaufman have another approach in their new paper, Consumer Biases and Firm Ownership: have the consumers own the firms. Here’s the abstract:

In this paper we show how ownership of the firm by its customers, as well as nonprofit status, can prevent the firm from exploiting consumer biases. By eliminating an outside residual claimant with control over the firm, these alternatives to investor ownership reduce the incentive of the firm to offer contractual terms that exploit the mistakes consumers make. However, customers who are unaware of their behavioral biases, and consequent vulnerability to exploitation, may fail to recognize this advantage of non-investor-owned firms and instead continue to patronize investor-owned firms. We present evidence from the consumer financial services market that supports our theory. Comparing contract terms, we find that mutually owned firms offer lower penalties, such as default interest rates, and higher up-front prices, such as introductory interest rates, than do investor-owned firms. However, consumers most vulnerable to these penalties are no more likely to use mutually owned firms.

Now, I am all for business forms competing with each other, including co-ops and capitalist owned firms.  As Henry Hansmann has written extensively, there is a place for non-shareholder-owned firms.

But Bubb & Kaufman go further.  It’s not enough for them just to let co-ops and capitalist-owned firms compete for consumers’ business.  They conclude that since misguided consumers continue to buy from the wrong firms, their judgment can’t be trusted.  Therefore, “policies that expand the market share of mutuals may be an effective way to reduce the social costs that result from consumers’ mistakes.”

I’m interested in seeing what these “policies that expand the market share of mutuals” might be.  Not to get too overheated or to indulge in slippery-slopism, but this seems to be an argument that capitalism plus regulation isn’t working, which would seem to lead to regulation of which types of firms can compete in which markets.

How far would this go? The authors suggest that “firm ownership plays a similar role in attenuating firms’ incentives to exploit consumer biases in other markets, such as education and health care.” And obviously consumers aren’t the only ones getting hurt. What about “policies that expand the market of” employee-owned firms?

Before we get on this slope, we might ask how far Bubb & Kaufman’s evidence can take us.  It’s hard to believe that, what with Elizabeth Warren and all, consumers could not have gotten the message that the capitalists are trying to cheat them, particularly in the financial services industry.  Could it be that their stubborn insistence on buying from these firms even when they have a choice means they just don’t believe it?  Or that capitalist-owned firms provide better value and products overall even if they insist on grabbing a bit more consumer surplus than customer-owned firms?  Or maybe even that the capitalist owned firms aren’t cheating the consumers after all because one-sided terms aren’t as bad as the pro-regulatory commentators would have us believe?

Before we start to regulate against capitalist-owned firms I’d like to see more evidence than just that consumers insist on dealing with them even when behavioral theories suggest they shouldn’t.

Larry Ribstein


Professor of Law, University of Illinois College of Law

3 responses to A new approach to consumer regulation: firm ownership


    As always, Larry makes a number of interesting points, but I think he’s reading a little too much into a fairly innocuous piece of the paper. I took this argument to be similar to the case for incentive-based pay in firms: sometimes it’s more efficient to adjust the incentive structure of the manager (in the case of mutuals, by blunting pay-for-performance) than it is to use legal rules to achieve the same outcome. So the authors’ point is just that it *might* be better to, say, subsidize the non-profit form; they’re not saying let’s make for-profit banks illegal.

    On the other hand, I think it’s a perfectly legitimate move to argue, as Larry does, that there’s no problem here that requires a response, either through regulation or the structure of firm incentives. As he notes, that’s an empirical question, although one on which I think he’s not sufficiently charitable to the extensive findings on the other side. It’s one thing to know that “capitalists are trying to cheat” you (even assuming that most bank consumers read elizabeth warren, or indeed can read at all), and quite another to know how. I know that good poker players can guess my hand, but I don’t know how to stop them from doing it.


    Agree with the comment. First, you do not see mutuals flourishing in every economic sector. More precisely, mutuals flourish where consumers face a monopolistic supplier (Hansmann). Second, you have to take into account the agency costs in mutuals which are higher than in corporations (in terms of inefficiency and private benefits of control). Mutuals managers have the incentives to maximize profits or size in order to maximize their salaries and perquisites. they pay better to the employees. When these agency costs are low, products offered by the mutuals offer a better quality/price relationship and clients choose Mutuals.


    ‘It’s hard to believe that, what with Elizabeth Warren and all, consumers could not have gotten the message that the capitalists are trying to cheat them’. Couldn’t have said it better if I said it myself.