Journal of Law, Economics, and Organization - Advance Access

Specialization, Firms, and Markets: The Division of Labor within and between Law Firms

Garicano, L., Hubbard, T. N. — 2008-05-07

This article uses confidential microdata from the Census of Services to examine law firms' field boundaries. We find that the share of lawyers working in field-specialized firms increases as market size increases and lawyers field specialize, indicating that transaction costs among lawyers, and not just complementarities in clients' demands, affect law firms' field boundaries. Moreover, we find that this pattern is mainly true when looking at fields where lawyers are involved in dispute resolution rather than in structuring transactions. We then analyze which combinations of specialists tend to work in the same firm and which tend not to do so. We relate our results to theories of law firms' boundaries from the organizational economics literature. Our evidence leads us to eliminate risk sharing as an important determinant of firms' field boundaries and narrows the set of possible monitoring or knowledge sharing explanations. (JEL D23, J44, L14, L84)

Auctions Versus Negotiations in Procurement: An Empirical Analysis

Bajari, P., McMillan, R., Tadelis, S. — 2008-05-07

Should the buyer of a customized good use competitive bidding or negotiation to select a contractor? To shed light on this question, we consider several possible determinants that may influence the choice of auctions versus negotiations. We then examine a comprehensive data set of private sector building contracts awarded in Northern California during the years 1995–2000. The analysis suggests a number of possible limitations to the use of auctions. Auctions may perform poorly when projects are complex, contractual design is incomplete, and there are few available bidders. Furthermore, auctions may stifle communication between buyers and sellers, preventing the buyer from utilizing the contractor's expertise when designing the project. Some implications of these results for procurement in the public sector are discussed (JEL D23, D82, H57, L14, L22, L74).

A Principal-Agent Theory of En Banc Review

Clark, T. S. — 2008-05-04

This paper adds to the existing literature on en banc rehearings in two ways. First, I incorporate theoretical results from the literature on Supreme Court certiorari decisions and argue that the ideological direction of panel decisions should influence the probability of en banc rehearing only in conjunction with the panel's ideological predisposition. Second, I build upon existing theories of en banc review by incorporating the multiple levels of the judicial hierarchy into the context in which the circuit decides to hear a case en banc. From these insights, I develop and test three hypotheses about the determinants of en banc review. Specifically, I contend that the ideological relationship between a three-judge panel, the full circuit, and the Supreme Court should all interact with the ideological orientation of the panel's decision when the circuit decides whether or not to review the panel en banc. Original data including all en banc rehearings between 1986 and 1996 are then used to test the theoretical predictions. The empirical analysis provides considerable support for the hypotheses. The findings represent two important advances in the study of the judicial hierarchy: They highlight the strategic interaction between ideological disposition and panel composition in the en banc review process and demonstrate the incentives created by the multiple levels of the federal judiciary.

Chinatown Revisited: Owens Valley and Los Angeles--Bargaining Costs and Fairness Perceptions of the First Major Water Rights Exchange

Libecap, G. D. — 2008-05-04

I examine a complicated bargaining problem in the acquisition of private land and water rights by Los Angeles in Owens Valley. This is a pivotal episode in the political economy of contemporary western water. More broadly, Owens Valley provides empirical evidence on how the gains from exchange were divided among the parties and how equity concerns shaped the process and succeeding assessment of market allocation. Negotiations for key properties took place within a bilateral monopoly context, and the bargaining strategies of both parties raised the transaction costs of exchange and formed fairness perceptions about the outcome of the exchange. I analyze the bargaining environment and estimate the determinants of when properties sold and the prices paid for land and water. Farmers who colluded did better by selling the properties than if they had remained in agriculture. Their "cartels," however, were not strong enough to secure more of the surplus from reallocating water from agriculture to urban demand. Most of the gains went to Los Angeles landowners, and this is a source of the notion of water "theft" that continues today.

Coming to the Nuisance: Revisiting Spur in a Model of Location Choice

Innes, R. — 2008-04-16

Building on recent work of Pitchford and Snyder (PS, 2003), this article models effects of alternative property rights regimes on sequential location decisions of two players. A new resident decides whether to "come to the nuisance" by locating next to an existing business or to locate elsewhere where there are no negative externalities between occupants. Faced with a new resident, the existing business can relocate. Once situated, local residents bargain to address negative externalities. However, location decisions are non-contractible. In this setting—contrary to PS—the first best is achieved by allocating property rights to the first party, entitling the initial resident to full compensation for damages. This rule is consistent with the Spur Industries decision. Allocating property rights to second parties excessively encourages residents to "come to the nuisance," whereas stronger first-party rights (injunctive or exclusion) excessively deter nuisances from moving to areas less prone to external harm. (JEL K11, K32, D62, D23)

Why Have Robberies Become Less Frequent but More Violent?

O'Flaherty, B., Sethi, R. — 2008-04-15

Although the incidence of robbery has declined sharply since the early 1990s, the proportion of robberies resulting in victim injury has increased and the rate of victim resistance has remained relatively stable. We provide a theoretical explanation for these trends. Deterrence policies that make robbery more costly for offenders result in a decline in the incidence of robbery through the exit of those with the best outside options. The group of robbers who exit consists disproportionately of those who would have fled in the face of victim resistance, and hence, the pool of remaining robbers is more likely to respond violently to noncompliance by victims. This effect is reinforced by what we call victim hardening: a change in the distribution of attributes in the victim pool that makes resistance more likely. This can arise, for instance, through an increase in crime avoidance by the most compliant victims. Deterrence and victim hardening both result in lower robbery rates and greater violence conditional on resistance but have opposing effects on the rate of resistance, thus accounting for its relative stability over time. (JEL K42, K14)

Judicial Independence Under a Divided Polity: A Study of the Rulings of the French Constitutional Court, 1959-2006

Franck, R. — 2008-04-15

This article analyzes whether the much-touted independence of the Conseil Constitutionnel (CC), the French Constitutional Court, is genuine. We construct a data set that comprises all the rulings of the CC between 1959 and 2006, taking into account the composition of the CC as well as the characteristics of the legislation reviewed by the judges. We find that the judges mainly rendered independent rulings when the polity was divided between left-wing and right-wing parties. (JEL D72, D73)

Revenue Sharing Distortions and Vertical Integration in the Movie Industry

Gil, R. — 2008-04-11

I analyze how variation in firm boundaries affect economic outcomes in the movie industry. Specifically, I focus on movie distributors and their contracts with exhibitors to show their movies on their screens. I argue that vertical integration solves the distortion on movie run length created by the revenue sharing contracts used in the industry. Since I observe the same movie showing in the same period under different organizational forms in the Spanish market, I use a difference on different approach to exploit this variation and study differences in outcomes across organizational forms. I show that integrated theaters run their own movies longer than other movies, and longer than nonintegrated theaters do. This effect is stronger for movies of more uncertain demand due to higher contractual complexity. I also find that integrated distributors specialize in the movies of higher demand uncertainty. (JEL L14, L22, L82)

An Economic Model of Whistle-Blower Policy

Heyes, A., Kapur, S. — 2008-01-03

"Whistle-blowing" is an increasingly common element of regulatory enforcement programs and one that is encouraged by recent legislation in the United States and elsewhere. We examine how responsive regulators should be to whistle-blower tip-offs and how severe should penalties be for wrongdoers detected in this way. Competing psychological theories as to what motivates employees to become whistle-blowers are operationalized as alternative behavioral heuristics. Optimal policy depends upon the motives attributed to whistle-blowers—which of the theories you subscribe to—but is not in general characterized by maximal penalties nor routine pursuit of complaints, even when pursuit is costless.

An Economic Analysis of Color-Blind Affirmative Action

Fryer, R. G., Loury, G. C., Yuret, T. — 2007-12-24

This article offers an economic analysis of color-blind alternatives to conventional affirmative action policies in higher education, focusing on efficiency issues. When the distribution of applicants' traits is fixed (i.e., in the short-run) color blindness leads colleges to shift weight from academic traits that predict performance to social traits that proxy for race. Using data on matriculates at several selective colleges and universities, we estimate that the short-run efficiency cost of "blind" relative to "sighted" affirmative action is comparable to the cost colleges would incur were they to ignore standardized test scores when deciding on admissions. We then build a model of applicant competition with endogenous effort in order to study long-run incentive effects. We show that, compared to the sighted alternative, color-blind affirmative action is inefficient because it flattens the function mapping effort into a probability of admission in the model's equilibrium.

"Implementing race-neutral programs will help educational institutions minimize litigation risks they currently face... . If we are persistent in implementing race-neutral approaches, the end result will be to fulfill the great words of Dr. Martin Luther King Jr., who dreamed of the day that all children will be judged by the content of their character and not the color of their skin."

—US Department of Education. Race-Neutral Alternatives in Postsecondary Education: Innovative Approaches to Diversity, Washington, D.C.: U.S. Department of Education, Office of Civil Rights March 2003, pp. 7, 40.

Environmental Liability in Transboundary Harms: Law and Forum Choice

Eckert, A., Smith, R. T., van Egteren, H. — 2007-12-12

We examine the economic consequences of choice of law and the choice of forum for the adjudication of transboundary harms. We examine strict liability and negligence and show that the socially optimal levels of care can be implemented in negligence only if the actions of the firm that caused the harm are adjudicated using the standards of the jurisdiction in which the harm occurs. This lends theoretical support to the extraterritorial application of domestic environmental laws in the case of transboundary pollution disputes.

Cashing by the Hour: Why Large Law Firms Prefer Hourly Fees over Contingent Fees

Garoupa, N., Gomez-Pomar, F. — 2007-12-06

Large law firms seem to prefer hourly fees over contingent fees. This article provides a moral hazard explanation for this pattern of behavior. Contingent legal fees tend to align the interests of the attorney with those of the client but not necessarily with those of the partnership. We show that the choice of hourly fees is a solution to a common agency problem. The article also discusses other possible explanations.

Incentives in Markets, Firms, and Governments

Acemoglu, D., Kremer, M., Mian, A. — 2007-12-06

We construct a simple career concerns model where high-powered incentives can distort the composition of effort by inducing excessive signaling. We show that in the presence of this type of career concerns, markets typically fail to limit competitive pressures and cannot commit to the desirable low-powered incentives. Firms may be able to weaken incentives and improve efficiency by obscuring information about individual workers' contribution to output, and thus reducing their willingness to signal through a moral-hazard-in-teams reasoning. However, firms themselves have a commitment problem, since firm owners would like to provide high-powered incentives to their employees to increase profits. When firms cannot refrain from doing so, government provision may be useful as a credible commitment to low-powered incentives. Governments may be able to achieve this even when operated by a self-interested politician. Among other reasons, this may happen because of the government's ability to limit yardstick competition and reelection uncertainty. We discuss possible applications of our theory to pervasive government involvement in predominantly private goods such as education and management of pension funds.

Has Devolution Injured American Workers? State and Federal Enforcement of Construction Safety

Morantz, A. D. — 2007-12-06

Although the issue of regulatory devolution has received much scholarly scrutiny, rigorous empirical studies of its effects on important policy outcomes are scarce. This article explores the effects of partial regulatory devolution in the occupational safety arena by exploiting a unique historical anomaly whereby some US states enforce protective labor regulations that are enforced elsewhere by the federal Occupational Safety and Health Administration. Analyzing data from the construction industry, this article contains several important findings. First, state inspectors use traditional enforcement tools more sparingly than their federal counterparts, typically citing fewer violations and collecting lower fines per violation. Second, although federal enforcement significantly lowers the estimated frequency of nonfatal construction injuries, it also predicts a significant increase in occupational fatalities. I suggest that although higher underreporting of nonfatal injuries in federally regulated states could explain this puzzling finding, it is equally possible that different regulatory styles have different "comparative advantages" in deterring nonfatal injuries on one hand and occupational fatalities on the other.

Urban Extremism

Brueckner, J. K., Glazer, A. — 2007-12-03

A current majority in some city, seeking to increase the probability that it will set policy in the following period, may initially adopt extremist policies that are particularly unattractive to the minority, leading some members of the minority to emigrate. This article develops a model to illustrate this idea, while providing examples that illustrate its relevance.

Trust in Transition: Cross-Country and Firm Evidence

Raiser, M., Rousso, A., Steves, F., Teksoz, U. — 2007-12-02

Using data from a large survey of firms across 26 transition economies, this article assesses the extent of trust in business relationships by measuring the level of prepayment demanded by suppliers, which we interpret as a measure of (dis)trust. We investigate a range of potential determinants of trust and find that trust among businesses is higher where confidence in third party enforcement through the legal system is higher. We also find that different types of business networks have a differential impact on the degree of trust between enterprises: networks based around family and friends help to build trust among firms, whereas networks based around enterprise insiders and government agencies appear to undermine trust. Our conclusion, based on the use of a unique multicountry enterprise data set, is that enterprises' room for maneuver in overcoming opportunism and distrust is much more limited by countrywide systemic factors than previously believed.

Bureaucratic Rents and Life Satisfaction

Luechinger, S., Meier, S., Stutzer, A. — 2007-12-02

Institutions affect bureaucrats' possibilities to acquire rents; they determine the degree of accountability and responsiveness of officials and of political control of the bureaucracy and, thereby, the size and distribution of rents in the public sphere. Those rents can involve higher wages, monetary and nonmonetary fringe benefits, and bribes. We propose a direct measure to capture the total of these rents: the difference in subjective well-being between bureaucrats and people working in the private sector. In a sample of 42 countries, we find large variations in the extent of rents in the public bureaucracy. The extent of rents is determined by differences in institutional and political constraints. In particular, we find judicial independence to be of major relevance for a tamed bureaucracy. Further, our measure for rents correlates with indicators of regulatory policies and perceptions of corruption.

Infectious Ethics: How Upright Employees Can Ease Concerns of Tacit Collusion

Mittendorf, B. — 2007-12-02

The recent spate of corporate scandals in the United States has led to a newfound emphasis on developing a culture of ethics within organizations. Many hope the leadership of a few can help persuade ethical behavior by others. This article suggests that direct interpersonal influences need not necessarily be present for individuals to spur such a culture. In this article, incentive contracts make use of relative performance evaluation, which gives rise to concerns of tacit collusion among employees. Ethical employees stand to alter the behavior of others, since their mere presence limits the number and size of potential collusive coalitions. As a result, the firm finds it much easier to motivate not only those who themselves are ethical but also those who act entirely in self-interest.

Democracy, Credibility, and Clientelism

Keefer, P., Vlaicu, R. — 2007-12-02

Despite having adopted the political institutions of established democracies, democratizing countries display a systematically different pattern of fiscal outcomes. This article attributes these differences to the low credibility of electoral promises in new democracies. We study a model of electoral competition where candidates have two costly means to make themselves credible: spending resources to communicate directly with voters and exploiting preexisting patron-client networks. The costs of building credibility are endogenous and lead to higher targeted transfers and corruption and lower public good provision. The analysis demonstrates that in low-credibility states, political appeals to patron-client networks may be welfare enhancing, but in the long run, they delay political development by discouraging direct appeals to voters that are essential for credible mass-based political parties. The model explains why public investment and corruption are higher in younger democracies and why democratizing reforms had greater success in Victorian England than in the Dominican Republic.

Corporate Boards of Directors: In Principle and in Practice

Williamson, O. E. — 2007-11-29

Numerous significant past and recent contributions to the literature on the efficacy of corporate boards of directors notwithstanding, a consensus has yet to develop. Partly this is due to a failure to agree on the ground rules, to which the use of different lenses through which to observe and interpret corporate boards is a contributing factor. This article examines corporate boards through the lens of contract/governance with the object of (1) uncovering the factors that are responsible for the intrinsic limitations of boards in monitoring and managing respects and, in consideration of these limitations, (2) advising on the merits of proposed reforms, to which credibility considerations and the integrity of delegation are relevant. A more accepting interpretation of practices regarded by many as problematic emerges, but not without qualifications and express concern for bad actors.

Accuracy Versus Falsification Costs: The Optimal Amount of Evidence Under Different Procedures

Emons, W., Fluet, C. — 2007-11-17

An arbiter can decide a case on the basis of his priors or he can ask for further evidence from the two parties to the conflict. The parties may misrepresent evidence in their favor at a cost. The arbiter is concerned about accuracy and low procedural costs. When both parties testify, each of them distorts the evidence less than when they testify alone. When the fixed cost of testifying is low, the arbiter hears both, for intermediate values one, and for high values no party at all. The arbiter's ability to remain uninformed as well as sequential testifying makes it more likely that the arbiter requires evidence.

Sustaining Cooperation with Joint Ventures

Cooper, R. W., Ross, T. W. — 2007-10-31

Antitrust agencies and courts have expressed concerns that joint ventures and strategic alliances between firms that compete in other markets might serve to reduce the vigor of their competition. This article explores a mechanism through which a joint venture between two (or more) firms in one market can serve to facilitate collusion in another market—even one unconnected vertically or horizontally by costs or demand. In the models studied here, play in one market has the effect of altering players' beliefs about their rivals' play in the second market. A joint venture in one market may provide a credible punishment mechanism for firms colluding in another market. The joint venture may also provide a vehicle for the transmission, between players, of information in a way that helps cooperative types find each other and collude in other markets.

Least-Cost Avoidance: The Tragedy of Common Safety

Dari-Mattiacci, G., Garoupa, N. — 2007-10-29

This article shows that the least-cost avoider approach in tort is not necessarily the optimal way to attain least-cost avoidance when accidents can be avoided by either of two parties. When parties do not observe each other's costs of care at the time of the accident and are unable to determine which party is the least-cost avoider, they fail to anticipate the outcome of the adjudication. Under these circumstances, accident avoidance becomes a commons problem because care by each individual party reduces the prospect of liability for both parties. As a result, parties suboptimally invest in care. We show that regulation removes this problem and is superior to tort liability both when parties act simultaneously and when they act sequentially. We further examine how different liability rules perform in this respect.

Why Divorce Laws Matter: Incentives for Noncontractible Marital Investments Under Unilateral and Consent Divorce

Wickelgren, A. L. — 2007-10-26

The Coase Theorem suggests that married couples will divorce if and only if doing so increases their joint surplus, regardless of the legal rules governing divorce. This does not mean, however, that divorce laws only affect the distribution of rents. Because the distribution of rents affects each spouse's incentives for noncontractible investments, divorce laws can affect the joint welfare of the couple. This article analyzes the effects of the consent divorce regime and the unilateral divorce regime on incentives for selfish and cooperative marital investments. Using these results, the article demonstrates how endogenous choice of marriage with noncontractible investments can explain some recent empirical results concerning the effects of the shift from consent divorce to unilateral divorce.

Matching Bankruptcy Laws to Legal Environments

Ayotte, K., Yun, H. — 2007-10-25

We study a model of optimal bankruptcy law in an environment where legal quality can vary along two dimensions: the expertise of judges and the quality of contract enforcement. We analyze a model in which a judicially influenced bankruptcy process can enhance the efficiency of incomplete contracts by conditioning the allocation of control rights in bankruptcy on firm quality. We consider the optimal balance of debtor and creditor interests as a function of the legal environment and show that the optimal degree of "creditor-friendliness" in the bankruptcy code increases as judicial ability to recognize firm quality falls and as the quality of contract enforcement deteriorates. Our model shows that a bankruptcy law that attempts to preserve going-concern value, such as US Chapter 11, requires judicial expertise to be effective. Where such expertise is unavailable, a law that focuses more on creditor recovery is preferred.