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On Monday evening, around 6:00 PM Eastern Standard Time, news leaked that the United States District Court for the Southern District of New York had decided to allow the T-Mobile/Sprint merger to go through, giving the companies a victory over a group of state attorneys general trying to block the deal.

Thomas Philippon, a professor of finance at NYU, used this opportunity to conduct a quick-and-dirty event study on Twitter:

Short thread on T-Mobile/Sprint merger. There were 2 theories:

(A) It’s a 4-to-3 merger that will lower competition and increase markups.

(B) The new merged entity will be able to take on the industry leaders AT&T and Verizon.

(A) and (B) make clear predictions. (A) predicts the merger is good news for AT&T and Verizon’s shareholders. (B) predicts the merger is bad news for AT&T and Verizon’s shareholders. The news leaked at 6pm that the judge would approve the merger. Sprint went up 60% as expected. Let’s test the theories. 

Here is Verizon’s after trading price: Up 2.5%.

Here is ATT after hours: Up 2%.

Conclusion 1: Theory B is bogus, and the merger is a transfer of at least 2%*$280B (AT&T) + 2.5%*$240B (Verizon) = $11.6 billion from the pockets of consumers to the pockets of shareholders. 

Conclusion 2: I and others have argued for a long time that theory B was bogus; this was anticipated. But lobbying is very effective indeed… 

Conclusion 3: US consumers already pay two or three times more than those of other rich countries for their cell phone plans. The gap will only increase.

And just a reminder: these firms invest 0% of the excess profits. 

Philippon published his thread about 40 minutes prior to markets opening for regular trading on Tuesday morning. The Court’s official decision was published shortly before markets opened as well. By the time regular trading began at 9:30 AM, Verizon had completely reversed its overnight increase and opened down from the previous day’s close. While AT&T opened up slightly, it too had given back most of its initial gains. By 11:00 AM, AT&T was also in the red. When markets closed at 4:00 PM on Tuesday, Verizon was down more than 2.5 percent and AT&T was down just under 0.5 percent.

Does this mean that, in fact, theory A is the “bogus” one? Was the T-Mobile/Sprint merger decision actually a transfer of “$7.4 billion from the pockets of shareholders to the pockets of consumers,” as I suggested in my own tongue-in-cheek thread later that day? In this post, I will look at the factors that go into conducting a proper event study.  

What’s the appropriate window for a merger event study?

In a response to my thread, Philippon said, “I would argue that an event study is best done at the time of the event, not 16 hours after. Leak of merger approval 6 pm Monday. AT&T up 2 percent immediately. AT&T still up at open Tuesday. Then comes down at 10am.” I don’t disagree that “an event study is best done at the time of the event.” In this case, however, we need to consider two important details: When was the “event” exactly, and what were the conditions in the financial markets at that time?

This event did not begin and end with the leak on Monday night. The official announcement came Tuesday morning when the full text of the decision was published. This additional information answered a few questions for market participants: 

  • Were the initial news reports true?
  • Based on the text of the decision, what is the likelihood it gets reversed on appeal?
    • Wall Street: “Not all analysts are convinced this story is over just yet. In a note released immediately after the judge’s verdict, Nomura analyst Jeff Kvaal warned that ‘we expect the state AGs to appeal.’ RBC Capital analyst Jonathan Atkin noted that such an appeal, if filed, could delay closing of the merger by ‘an additional 4-5’ months — potentially delaying closure until September 2020.”
  • Did the Court impose any further remedies or conditions on the merger?

As stock traders digested all the information from the decision, Verizon and AT&T quickly went negative. There is much debate in the academic literature about the appropriate window for event studies on mergers. But the range in question is always one of days or weeks — not a couple hours in after hours markets. A recent paper using the event study methodology analyzed roughly 5,000 mergers and found abnormal returns of about positive one percent for competitors in the relevant market following a merger announcement. Notably for our purposes, this small abnormal return builds in the first few days following a merger announcement and persists for up to 30 days, as shown in the chart below:

As with the other studies the paper cites in its literature review, this particular research design included a window of multiple weeks both before and after the event occured. When analyzing the T-Mobile/Sprint merger decision, we should similarly expand the window beyond just a few hours of after hours trading.

How liquid is the after hours market?

More important than the length of the window, however, is the relative liquidity of the market during that time. The after hours market is much thinner than the regular hours market and may not reflect all available information. For some rough numbers, let’s look at data from NASDAQ. For the last five after hours trading sessions, total volume was between 80 and 100 million shares. Let’s call it 90 million on average. By contrast, the total volume for the last five regular trading hours sessions was between 2 and 2.5 billion shares. Let’s call it 2.25 billion on average. So, the regular trading hours have roughly 25 times as much liquidity as the after hours market

We could also look at relative liquidity for a single company as opposed to the total market. On Wednesday during regular hours (data is only available for the most recent day), 22.49 million shares of Verizon stock were traded. In after hours trading that same day, fewer than a million shares traded hands. You could change some assumptions and account for other differences in the after market and the regular market when analyzing the data above. But the conclusion remains the same: the regular market is at least an order of magnitude more liquid than the after hours market. This is incredibly important to keep in mind as we compare the after hours price changes (as reported by Philippon) to the price changes during regular trading hours.

What are Wall Street analysts saying about the decision?

To understand the fundamentals behind these stock moves, it’s useful to see what Wall Street analysts are saying about the merger decision. Prior to the ruling, analysts were already worried about Verizon’s ability to compete with the combined T-Mobile/Sprint entity in the short- and medium-term:

Last week analysts at LightShed Partners wrote that if Verizon wins most of the first available tranche of C-band spectrum, it could deploy 60 MHz in 2022 and see capacity and speed benefits starting in 2023.

With that timeline, C-Band still does not answer the questions of what spectrum Verizon will be using for the next three years,” wrote LightShed’s Walter Piecyk and Joe Galone at the time.

Following the news of the decision, analysts were clear in delivering their own verdict on how the decision would affect Verizon:

Verizon looks to us to be a net loser here,” wrote the MoffettNathanson team led by Craig Moffett.

…  

Approval of the T-Mobile/Sprint deal takes not just one but two spectrum options off the table,” wrote Moffett. “Sprint is now not a seller of 2.5 GHz spectrum, and Dish is not a seller of AWS-4. More than ever, Verizon must now bet on C-band.”

LightShed also pegged Tuesday’s merger ruling as a negative for Verizon.

“It’s not great news for Verizon, given that it removes Sprint and Dish’s spectrum as an alternative, created a new competitor in Dish, and has empowered T-Mobile with the tools to deliver a superior network experience to consumers,” wrote LightShed.

In a note following news reports that the court would side with T-Mobile and Sprint, New Street analyst Johnathan Chaplin wrote, “T-Mobile will be far more disruptive once they have access to Sprint’s spectrum than they have been until now.”

However, analysts were more sanguine about AT&T’s prospects:

AT&T, though, has been busy deploying additional spectrum, both as part of its FirstNet build and to support 5G rollouts. This has seen AT&T increase its amount of deployed spectrum by almost 60%, according to Moffett, which takes “some of the pressure off to respond to New T-Mobile.”

Still, while AT&T may be in a better position on the spectrum front compared to Verizon, it faces the “same competitive dynamics,” Moffett wrote. “For AT&T, the deal is probably a net neutral.”

The quantitative evidence from the stock market seems to agree with the qualitative analysis from the Wall Street research firms. Let’s look at the five-day window of trading from Monday morning to Friday (today). Unsurprisingly, Sprint, T-Mobile, and Dish have reacted very favorably to the news:

Consistent with the Wall Street analysis, Verizon stock remains down 2.5 percent over a five-day window while AT&T has been flat over the same period:

How do you separate beta from alpha in an event study?

Philippon argued that after market trading may be more efficient because it is dominated by hedge funds and includes less “noise trading.” In my opinion, the liquidity effect likely outweighs this factor. Also, it’s unclear why we should assume “smart money” is setting the price in the after hours market but not during regular trading when hedge funds are still active. Sophisticated professional traders often make easy profits by picking off panicked retail investors who only read the headlines. When you see a wild swing in the markets that moderates over time, the wild swing is probably the noise and the moderation is probably the signal.

And, as Karl Smith noted, since the aftermarket is thin, price moves in individual stocks might reflect changes in the broader stock market (“beta”) more than changes due to new company-specific information (“alpha”). Here are the last five days for e-mini S&P 500 futures, which track the broader market and are traded after hours:

The market trended up on Monday night and was flat on Tuesday. This slightly positive macro environment means we would need to adjust the returns downward for AT&T and Verizon. Of course, this is counter to Philippon’s conjecture that the merger decision would increase their stock prices. But to be clear, these changes are so minuscule in percentage terms, this adjustment wouldn’t make much of a difference in this case.

Lastly, let’s see what we can learn from a similar historical episode in the stock market.

The parallel to the 2016 presidential election

The type of reversal we saw in AT&T and Verizon is not unprecedented. Some commenters said the pattern reminded them of the market reaction to Trump’s election in 2016:

Much like the T-Mobile/Sprint merger news, the “event” in 2016 was not a single moment in time. It began around 9 PM Tuesday night when Trump started to overperform in early state results. Over the course of the next three hours, S&P 500 futures contracts fell about 5 percent — an enormous drop in such a short period of time. If Philippon had tried to estimate the “Trump effect” in the same manner he did the T-Mobile/Sprint case, he would have concluded that a Trump presidency would reduce aggregate future profits by about 5 percent relative to a Clinton presidency.

But, as you can see in the chart above, if we widen the aperture of the event study to include the hours past midnight, the story flips. Markets started to bounce back even before Trump took the stage to make his victory speech. The themes of his speech were widely regarded as reassuring for markets, which further pared losses from earlier in the night. When regular trading hours resumed on Wednesday, the markets decided a Trump presidency would be very good for certain sectors of the economy, particularly finance, energy, biotech, and private prisons. By the end of the day, the stock market finished up about a percentage point from where it closed prior to the election — near all time highs.

Maybe this is more noise than signal?

As a few others pointed out, these relatively small moves in AT&T and Verizon (less than 3 percent in either direction) may just be noise. That’s certainly possible given the magnitude of the changes. Contra Philippon, I think the methodology in question is too weak to rule out the pro-competitive theory of the case, i.e., that the new merged entity would be a stronger competitor to take on industry leaders AT&T and Verizon. We need much more robust and varied evidence before we can call anything “bogus.” Of course, that means this event study is not sufficient to prove the pro-competitive theory of the case, either.

Olivier Blanchard, a former chief economist of the IMF, shared Philippon’s thread on Twitter and added this comment above: “The beauty of the argument. Simple hypothesis, simple test, clear conclusion.”

If only things were so simple.

I am very pleased to report that Kevin Murphy – economist extraordinaire, recipient of the MacArthur Fellowship, Bates Clark Medal winner, and of course, fellow UCLA Bruin — has agreed to join Charles River Associates as a Senior Consultant beginning May 2013 when his contract with Navigant Economics expires.  As a fellow Senior Consultant at CRA, and a fan of Murphy’s academic and expert work, I’m very pleased that he will be joining the firm.

From the CRA press release:

Charles River Associates (NASDAQ: CRAI), a worldwide leader in providing economic, financial, and management consulting services, today announced that Kevin M. Murphy, the George J. Stigler Distinguished Service Professor of Economics, Department of Economics and Booth School of Business, University of Chicago, has entered into an agreement to become a senior consultant to CRA’s Antitrust & Competition Economics Practice. Professor Murphy is expected to begin working with CRA in May 2013.

“Kevin Murphy is widely regarded as one of the smartest economists in the world and we are honored and thrilled about his decision to become a senior consultant to Charles River Associates,” said CRA’s President and Chief Executive Officer Paul Maleh. “Professor Murphy has an outstanding reputation as an extremely effective expert in numerous antitrust, labor and other engagements. In his academic research, Professor Murphy has developed leading theories and analyses that explain how economic incentives influence social phenomena, such as addiction, and determine economic outcomes, including wage inequality, unemployment, and the economic value of health and medical research. Professor Murphy has a reputation for being exceptionally creative, asking the questions not being asked, and developing innovative and informative economic models. Simply put—he is an economist in a league of his own. We look forward to working with Professor Murphy and continuing CRA’s tradition of teaming our highly-talented consulting professionals with renowned academics and economists to best serve clients.”

Dr. Steven C. Salop, a Senior Consultant to CRA and Professor of Economics and Law at Georgetown University Law Center, said, “We are very excited to have Kevin Murphy joining CRA. Besides being one of the most creative economists of his generation, Kevin is both articulate and down to earth. We are looking forward to having him as a colleague and a leader.”

Congratulations to Dr. Murphy and Charles River Associates.

DISCLOSURE: As mentioned, I am a Senior Consultant to CRA.

Another day, another paper showing evidence of the negative effect on market efficiency of bans on short-selling.  Today it’s Yerkes, Regulatory Trading Restrictions, Overvaluation, and Insider Selling.  Here’s the abstract:

A contentious debate is emerging over the regulatory response to the financial crisis. This paper takes advantage of a rare opportunity to empirically test sweeping short sale constraints. Specifically, I analyze 2008 trading restrictions which prohibited short selling in all U.S. financial stocks. It is not clear whether restrictions keep negative sentiment off the market, sending prices up, or discourage ownership by stock lenders, sending prices down. It is also debatable how coincident events such as TARP affect prices, since avoiding bankruptcy is beneficial, but equity issuance and poor capitalization is not. The findings in this paper have three important implications for market participants. First, positive abnormal return and increased insider selling are consistent with an overvaluation hypothesis. The possibility of overvaluation due to TARP is ruled out since only a small percentage of restricted firms receive TARP funding and prices react negatively when they do. The overvaluation finding is consistent with prior studies of trading restrictions, such as IPO lockups. Second, additional evidence is provided on the documented relationship between institutional ownership and short sale constraints. Firms with low institutional ownership, low short interest, small market cap, and firms traded on the NASDAQ were least affected by the ban. This is relevant since 95% of stocks are not constrained by institutional ownership levels. Finally, short selling is known to facilitate information revelation and I find large declines in short interest result in less market efficiency.

Want more evidence of the efficiency effects of short-selling and the inefficiency of banning it?  Try this, this, and this. Here’s one of many posts on government’s war on the shorts (aka killing the messenger). And Bruce Kobayashi and my broader criticism of regulation of “outsider trading.”

Today’s WSJ reports on the US’s slide in stock listings, which explains the NYSE/Deutsche Borse move.  It notes that

  • U.S. stock listings are down by 43%, or by 3800, since 1997.
  • Listings outside the U.S. have doubled.  
  • U.S. IPOs since 2000 are down 71% from the 1990s. 
  • IPOs by VC-backed startups are down from 90% in the 1980s to 15%.

Some reasons:  firms have lower compliance costs, fewer shareholder suits, lower d & o insurance costs, and lower listing fees, no SOX (or Dodd-Frank).

Nasdaq is seeking to compete with London’s AIM by opening an exchange for small companies that don’t meet its general listing requirements.

But this won’t solve the problem.  In the long run, the US securities laws compete in a global market.  Although other factors, including the growth of foreign markets, help explain the above shifts, these other factors increase the competitive pressure on US law.  Congress and the SEC are going to have to stop acting like they’re alone in the world.

Six years ago Henry Butler and I wrote about what we called the Sarbanes-Oxley Debacle. Well, it’s still a debacle after all these years, and having significant effects on business and international competition.

Yesterday’s WSJ opined, concerning the potential NYSE/Deutsche Borse merger that 

whoever ends up owning the iconic trading venue, the question is whether Washington will allow any U.S. stock exchange to be an attractive destination for young companies. It’s clear to most stock-exchange watchers that no business combination can relieve the burden that the 2002 Sarbanes-Oxley (Sarbox) law places on firms seeking to join the public markets. This is no doubt one of the reasons that Mr. Niederauer sees advantages in a merger with a foreign partner that has most of its business overseas.

The editorial suggests expanding Dodd-Frank’s exemption from SOX 404(b) from companies with less than $75 million in public securities to those with less than a $250 million float. It relies on the SEC’s own 2009 study showing that the vast majority of companies find that the benefits of SOX compliance outweigh the costs.

Ironically, the same issue of the WSJ reports that Chuck Schumer is “favoring the German deal as the best way to protect New York.” Schumer says: “My sole motivation here is keeping New York the No. 1 financial center in the world, and I will be guided by that criteria far above anything else in making a decision.”

Schumer is supposedly worried about Chicago’s rise in the competing derivatives market.  But Roger Altman, whose Evercore Partners is advising Nasdaq on its proposal to take over the NYSE, says “the greatest threat to New York is not Chicago. It’s Hong Kong and China, by a mile.”

All of which suggests that Schumer should have thought about all this back when he was helping to provide an entrée for these foreign competitors by backing SOX and Dodd-Frank.  There’s still time for him to read Butler and my book.

Each fall I invite leading corporate scholars to present and discuss their recent work to faculty and students in the Illinois Corporate Colloquium.  I plan to discuss these papers here on TOTM. 

This semester we started with Kim Krawiec (Duke) and her paper (with Lissa Broome and John Conley), Dangerous Categories: Narratives of Corporate Board Diversity, forthcoming in the North Carolina Law Review.  Here’s the abstract:

In this article, we report the results of a series of interviews with corporate directors about racial, ethnic, and gender diversity on corporate boards. On the one hand, our respondents were clear and nearly uniform in their statements that board diversity was an important goal worth pursuing. Yet when asked to provide examples or anecdotes illustrating why board diversity matters, many subjects acknowledged difficulty in illustrating theory with reference to practice. This expressed reluctance to come to specific terms with general claims about the value of director diversity inspired our title phrase: dangerous categories. That is, while “diversity” evokes universal acclaim in the abstract, our respondents’ narratives demonstrate that it is an elusive and even dangerous subject to talk about concretely.

The paper is an interesting take on what board members think about diversity in their midst.

 It’s also timely, as we just got a plea from SEC Commissioner Aguilar that board diversity isn’t being taken seriously enough.  The Commissioner says (footnotes omitted):

 There are many who believe that a diverse board improves outcomes, particularly financial performance and that it improves decision-making processes, which may in turn improve firm performance. Many studies indicate that such diversity in the boardroom results in real value for both companies and shareholders. In fact, a report commissioned by the California Public Employees’ Retirement System (CalPERS) found that companies that have diverse boards perform better than boards without diversity. The report — Board Diversification Strategy: Realizing Competitive Advantage and Shareowner Value — stated that companies without ethnic minorities and women on their boards eventually may be at a competitive disadvantage and have an under-performing share value. The report also found that a selected group of companies with a high ratio of diverse board seats exceeded the average returns of the Dow Jones and NASDAQ indices over a five-year period. Notwithstanding these studies, there is a persistent lack of diversity in corporate boardrooms across this country — women and minorities remain woefully underrepresented.

Commissioner Aguilar notes that when the SEC requested input in 2009 on the need for more information regarding board diversity “we were deluged with letters. These letters were overwhelmingly supportive, with approximately 90% expressing support for disclosure of information related to race and gender diversity on the board.” This led to provisions in a recent SEC rule that require firms to disclose whether diversity is a factor in considering candidates for nomination to the board of directors, how firms consider diversity and how they assess the effectiveness their diversity policies.

The Commissioner thinks still more disclosure is required as to “the concrete steps taken to develop a slate of diverse candidates for a position.”  He hopes this will lead to substantive governance changes in the form of more minorities and women as directors. And he also hopes that the SEC itself will become more diverse, consistent with the provision for a new SEC Office of Minority and Women Inclusion in Section 342 of Dodd-Frank.

 Recent calls for diversity extend beyond the boardroom and the SEC.  Judge Harold Baer recently issued an order (see American Lawyer and ATL) that two firms serving as lead counsel in a securities class action “make every effort” to staff the case with at least one minority and one woman. He reasoned that “[t]his proposed class includes thousands of participants, both male and female, arguably from diverse backgrounds, and it is therefore important to all concerned that there is evidence of diversity, in terms of race and gender, in the class counsel I appoint.”

So this brings us back to Broome, Conley & Krawiec’s paper.  If we want to know whether diversity is important and why, let’s ask boards themselves.  What we learn, as discussed in the abstract, is that they either don’t know or won’t say.

These interviews also suggest that the board actually doesn’t do much of importance.  Their reasoning about diversity seems to indicate that they’re opining on operational matters already handled by executives, such as product design, rather than engaging in the policymaking we generally associate with the board.  

Maybe the interviews don’t deal with what the board really does, which is to occasionally intervene in crisis situations.  But this just raises another question:  Does diversity help the board in situations like this?  Possibly having women helps firms deal with sexual harassment allegations  (HP).  But does it help with financial unraveling (Lehman) or environmental disaster (BP)?  Wouldn’t it be better in these situations to select purely for managerial competence?

Or is the board purely symbolic?  Maybe it helps a consumer products company sell products by showing that it really is like the consumers it’s selling to.  In other words, the board is the corporation’s face. 

But, then, why do we need a board for this?  We could hire diverse employees and executive officers.  The board is important in this regard only if it’s running the company, which gets back to whether it actually is doing this.

With respect to the article’s “dangerous categories” point, there is a problem that the paper mentions but doesn’t emphasize concerning corporate social responsibility:  if the board admits that diversity relates to something other than quality of management, is it admitting uncomfortable deviation from profit-maximization?  I’m not sure this is a problem since, even if diversity is nothing more than putting a comforting face on the corporation, this arguably helps it sell products.  But are the questioned board members unsure even about that?

In the end, the paper left me wondering how far we have come since Myles Mace’s interviews with directors reflected in Directors: Myth and Reality, 90 (1971):

You’ve got to have the names of outside directors who look impressive in the annual report. They are, after all, nothing more or less than ornaments on the corporate Christmas tree. You want good names, you want attractive ornaments. You want to communicate to the various publics that if any company is good enough to attract the president of a large New York bank as a director, for example, it just has to be a great company.

Forty years later Broome, Krawiec and Conley, like Mace, interviewed directors.  What they found is at least consistent with the notion that directors are still “ornaments” after all these years.

My Missouri colleague, Peter Klein, of Organizations and Markets fame (and, like Larry, a proud non-voter), has been asked to contribute a book chapter on the Austrian theory of the firm and the law. Peter, who has written extensively on the Austrian theory of the firm and maintains an online bibliography on the subject, is an expert on the economics. He asked me to give him some thoughts on the law — i.e., which business law doctrines cohere or conflict with Austrian insights on the nature of the firm.

I’m posting my initial thoughts on the matter in the hope that readers may enlighten us on additional business law doctrines that reflect or reject Austrian thinking. (And, of course, please let me know where I’m off base.) You can either respond to this post or email Peter or me directly.

Before I get into a discussion of specific business law doctrines, let me provide some (extremely cursory!) background on Austrian thought.

AUSTRIAN THOUGHT ON ECONOMIC PLANNING, THE BUSINESS FIRM, AND THE LAW

A hallmark of Austrian thinking, especially as articulated by F.A. Hayek, is the notion that the information required to allocate productive resources to their highest and best ends, and thereby to maximize wealth, is not readily available to any individual or central authority. Instead, it is widely dispersed among individuals throughout society. Accordingly, attempts to maximize value by allocating productive resources in a centralized fashion — i.e., according to the dictates of central planners — are destined to fail. Those planners lack access to important information (most notably, information about how individual consumers value competing uses of productive resources) and could not effectively process all that information, much of which is conflicting, even if it were accessible.

But, say the Austrians, there’s no need to despair. In a society with well-defined, freely transferable property rights, the impossibility of effective central planning presents little problem. As individuals engage in trades in an attempt to better themselves, prices for productive resources will emerge. Those prices incorporate all available information about the relative value of competing uses of a productive resource (i.e., the person willing to pay the highest price for something will create the most value from it and should possess it if the goal is to maximize wealth). They present that information in a simple, useful form (i.e., one need not worry about calculating the net effect of conflicting bits of information about a resource’s highest and best use; the price mechanism will do so). And they motivate economic actors to take precisely the steps that will maximize total wealth (i.e., relatively high prices for a resource induce producers to make more of it and consumers to substitute away from it; relatively low prices induce less production and more consumption of the resource). Thus, when property rights are well-defined and freely transferable, prices will create a spontaneous order that trumps anything achievable using central planning.

But wait a minute. Isn’t the business firm an instance of central planning?  Within a firm, productive resources are allocated according to the dictates of “central planners” — i.e., managers.  Indeed, Ronald Coase famously observed that the defining hallmark of the firm is “the supersession of the price mechanism.”  Does it even make sense, then, to talk about an Austrian theory of the firm? 

Well, yes, if one understands the business firm as an instance of spontaneous order.  In the so-called “socialist calculation debate,” in which the Austrians contended that economic welfare would be greater in a free economy than in a centrally planned one, the central planners were expected to have state power (legitimate power to coerce using force) and were not expected to face significant competition.  The “planners” within a firm, by contrast, cannot forcefully coerce their subjects (they must procure consent from resource providers), and they face significant competition from other business firms.  These two considerations constrain planning within a business firm so that it is used only when the benefits it generates — chiefly, a reduction in the costs of using the market (i.e., transaction costs) — exceed the losses it occasions in terms of allocative inefficiency (i.e., mistakes by planners attempting to allocate resources optimally) and agency costs (i.e., losses from planners’ opportunism and neglect).  Thus, in the sort of economic system advocated by the Austrians — one coupling well-defined, enforceable, and transferable property rights with broad freedom to contract — one would expect business firms to emerge spontaneously as entrepreneurs seek to minimize the sum of transaction costs, allocative inefficiencies, and agency costs.  One would also expect the boundaries of the firm to change (spontaneously) as technological and other developments alter the relative costs of bringing functions within the firm rather than procuring them on the market.  Such thinking coheres nicely with the Coasean understanding of the firm.

Before looking at specific business law doctrines that reflect or reject Austrian thinking, I should note one other Austrian (specifically, Hayekian) distinction, this one between types of legal rules.  Some legal rules are general in their application, are “purpose-independent” (meaning that the law-giver isn’t trying to achieve some specific social outcome but is instead trying to resolve a dispute in accordance with the parties’ settled expectations), and have the effect of setting clear expectations so that parties may confidently predict outcomes in structuring their affairs.  Hayek refers to these sorts of rules as nomos.  Other legal rules are more akin to specific orders from a central authority seeking to achieve some specific purpose.  Such “teleological” rules Hayek refers to as thesis

In light of their emphasis on the knowledge problem and the impossibility of effective central planning, the Austrians (most notably Hayek) contended that legitimate law is nomos.  Thesis is something other than genuine law.  The common law, for the most part, is nomos.  Most (but not all) legislation is thesis.  The characterization of any piece of legislation will depend on whether it amounts to specific orders aimed at achieving a set purpose (e.g., the new federal health care law), in which case it is thesis, or is instead simply seeking to codify purpose-independent rules that settle parties’ expectations and enable them to order their affairs in light of the information to which they alone are privy (e.g., the Uniform Commercial Code), in which case it is nomos.   

Below the fold, I discuss some business law doctrines that cohere with Austrian thinking and others that conflict.  Not surprisingly, the doctrines that are most consistent with the Austrian view of the firm are nomos-like; the inconsistent legal doctrines are thesis.
Continue Reading…

This post is from Phil Weiser (Colorado)

It is trite to say that “we are all Schumpeterians now.”  When it comes to appreciating the importance of innovation and entrepreneurship, however, we are.  Schumpeter, unfortunately, did not leave a theory of innovation that lends itself to easy application to public policy prescriptions, as Brad De Long has explained so clearly.  By so clearly highlighting the role that antitrust law and intellectual property policy can play in spurring innovation, Michael Carrier has done the field a great service.  Indeed, Mike has written an impressive, ambitious, and important book.  But in a post like this, I come not to praise him, but to take pot shots from the peanut gallery.

My first pot shot is one that Mike knows is coming—and footnote 143 reveals as much.  On Mike’s view, the Trinko/Credit Suisse double header is, at worst, benign and, at best, on the money.  This view of Trinko leads Mike to predict that the Supreme Court will take an aggressive posture as to “pay for delay” pharmaceutical settlements that have developed as an unintended consequence of the Hatch-Waxman Act.  The problem with this view is that Mike overlooks the most disturbing aspect of Trinko—it made the judgment about the effectiveness of the regulatory regime (in that case as to the FCC) on a motion to dismiss.  Notably, in the AT&T antitrust litigation, this issue was a question of fact and not presumed based on the mere presence of a regulatory regime.  I have the same concern about Credit Suisse, which took a generous view of the SEC’s regulatory effectiveness not long after that agency (and the self regulatory organization upon which it relied) failed to unearth a cartel arrangement at the NASDAQ that was only revealed through antitrust litigation.  But I have written about this before, as footnote 143 recounts.

My second point is to underscore a point Mike makes in regard to the Microsoft antitrust litigation—whether the presence of intellectual property rights (IPRs) should justify a firm’s decision to withhold access to application programming interfaces or protocols necessary to facilitate interoperability.  I agree with his conclusion that IPRs should not displace antitrust oversight.  Again, to invoke U.S. v. AT&T, consider that, had the relevant interconnection issue in that case involved patented interfaces, it would have come out differently under the theory pressed by Microsoft.  Given that software patents are controversial to begin with, awarding the recipient of a patent on an application programming interface or communications protocol a get-out-jail free card is hard to justify.  That said, I would have liked to see Mike develop his view of Microsoft case.  He may well have resisted doing so out of concerns related to space, a lack of historical distance, or that he was not sure what type of verdict to pronounce on the decree.  At a minimum, I believe if safe to say that the case underscores the challenges of “regulating interoperability,” of which the IPR issues are only a relatively small part of the overall equation.

For a final point, let me close on the discussion of standard setting organizations (SSOs).  The role of SSOs is potentially very important and, until recently, they operated with a limited degree of awareness of the regulatory challenges they face as to, among other issues, the threat of patent holdout.  As I have explained elsewhere, there is a strong argument that SSOs should be given the type of latitude that Mike calls for in facilitating cooperation and managing the behavior of individual firms.  Where Mike could drill down deeper, however, is to evaluate the institutional challenges of how to enforce commitments by firms participating in standard setting organizations to restrict their collection of royalties to reasonable and non-discrimination (RAND) terms.  Most question-begging is whether the FTC’s Section 5 authority will ultimately prove to be an important tool in this regard (as used in the N-Data case).  In the wake of the Supreme Court’s denial in the Rambus case, there will be undoubtedly more pressure for the FTC to use this tool.

Mike’s book provides lots of fodder for discussion and will provide policymakers with a rich set of proposals to evaluate.  I look forward to hearing his voice on these issues over the years ahead.

As I blogged earlier (see here), Nasdaq has been working on becoming an “exchange” since 2001. As of Monday, it’s official (see here and here). As I said before:

From my perspective (law professor who writes in the securities
regulation area), one big positive of the change is that now both the
NYSE and NASDAQ can correctly be referred to collectively as “exchanges.� In past scholarship, I’ve struggled with the right collective term—�exchanges� was not technically correct and neither was “markets.�

Nasdaq announced today (press release) that it is creating a third market tier called NASDAQ Global Select Market which will have the highest initial listing standards of any stock market in the world. According to Nasdaq’s CEO Robert Greifeld:

NASDAQ is raising its financial listing standards above that of any other market globally to attract and retain companies that want to trade on the market with the highest listing standards.

NASDAQ’s view is that the best companies globally will migrate to the markets with the best standards. We believe that the best, most intelligent standards come about when markets and companies recognize what is good for investors and initiate improvements from within. NASDAQ invites markets, companies and investors to review our standards, emulate us, or suggest other types of enhancements. In this way we hope to create a reasoned race to the top for markets and companies.

Nasdaq also announced that it is changing the name of what will be the second market tier from the NASDAQ National Market to the NASDAQ Global Market. The third market tier will be the NASDAQ Capital Market.

The W$J characterizes the new tier as “the latest move in Nasdaq Chief Executive Robert Greifeld’s strategy to get more large companies to move their stocks to Nasdaq from the larger New York Stock Exchange.â€?

According to this CFO.com article, London Stock Exchange listed companies are concerned that the acquisition of the LSE by a U.S. exchange will subject the companies to SOX (recall that Nasdaq’s $4.2 billion unsolicited bid for the LSE was rejected but it has since acquired 24% of LSE shares). And LSE companies should be concerned considering the high costs of SOX compliance but questionable benefits. However, according to the article:

Callum McCarthy, chairman of Britain’s Financial Services Authority, stated that the FSA and the Securities and Exchange Commission agree that U.S. ownership of the LSE would not “in and of itself” mean that U.S. regulations would apply to LSE-listed or -quoted companies . . . .

The statement could have certainly gone further in comforting LSE companies. They can, however, take more comfort from market realities. If the Nasdaq were to acquire the LSE, it would do everything possible to keep it outside the reach of SOX. A primary objective of Nasdaq acquiring a foreign exchange is to be able to provide a non-SOX listing option so that it can get a piece of the increasing number of deals now being done outside of the U.S. in large part due to SOX. As the W$J recently noted (see here):

In 2000, nine of every 10 dollars raised by non-U.S. companies through new stock offerings were raised in the U.S. Last year the reverse was true: nine of every 10 dollars were raised abroad.

Today’s W$J has an article describing some of the option granting practices at Brocade (see here). Among them was the creation of a one member compensation committee consisting of Brocade’s CEO, Greg Reyes. The article gives the following as the reasoning:

The process of granting stock options was cumbersome because the compensation committee met only every three months. Mr. Reyes said he wanted to speed it up so he could recruit better in those hectic days in Silicon Valley. The board gave him authority to approve options by himself, including their exercise prices.

He said the idea was supported by Larry W. Sonsini, one of the most prominent attorneys in Silicon Valley, who was then a Brocade director. A spokeswoman for his law firm, Wilson, Sonsini,Goodrich & Rosati in Palo Alto, said that one-person stock-option committees are legal under the laws of Delaware. That’s where Brocade is incorporated. “One-person stock-option committees were adopted during a time of intense competition for hiring and retaining employees and the ability to act quickly was critical,” said the spokeswoman for the law firm.

Wilson, Sonsini is of course correct. DGCL Sec. 141(c)(1) provides: “The board of directors may, by resolution passed by a majority of the whole board, designate 1 or more committees, each committee to consist of 1 or more of the directors of the corporation.” (emphasis added). The MBCA has a similar provision. While it may not represent best corporate practice to have single member committees, given the statutory language it is certainly within the board’s business judgment as to whether it is appropriate in a particular case.

With respect to compensation committees, however, NYSE and Nasdaq listing standards adopted in 2003 make it clear that the CEO cannot be on the committee–it has to be composed entirely of independent directors. Note that the standards do not specify whether a compensation committee can consist of a single independent director, but they use the plural “directors” in a way that implies the answer is no.

Although listing standards may make the question moot for most public companies, if you were a director, would you sign-off on a single member compensation committee? My inclination is “no.” Even during “a time of intense competition for hiring and retaining employees,” it seems to me that at least three directors could make themselves readily available to approve option grants through written consent. Executive compensation is just too riddled with temptation for abuse to leave to one person.