Journal of Law, Economics, and Organization - recent issues

Editor's Note

Ayres, I. — 2008-03-04

Abortion Access and Risky Sex Among Teens: Parental Involvement Laws and Sexually Transmitted Diseases

Klick, J., Stratmann, T. — 2008-03-04

Laws requiring minors to seek parental consent or to notify a parent prior to obtaining an abortion raise the cost of risky sex for teenagers. Assuming choices to engage in risky sex are made rationally, parental involvement laws should lead to less risky sex among teens, either because of a reduction of sexual activity altogether or because teens will be more fastidious in the use of birth control ex ante. Using gonorrhea rates among older women to control for unobserved heterogeneity across states, our results indicate that the enactment of parental involvement laws significantly reduces risky sexual activity among teenage girls. We estimate reductions in gonorrhea rates of 20% for Hispanics and 12% for whites. Although we find a relatively small reduction in rates for black girls, it is not statistically significant. We speculate that the racial heterogeneity has to do with differences in family structure across races.

The Effects of the Fourth Amendment: An Economic Analysis

Mialon, H. M., Mialon, S. H. — 2008-03-04

We develop an economic model of crime and search that allows us to analyze the effects of the Fourth Amendment's exclusionary rule on crime and privacy. We find that the rule always increases crime but has two opposing effects on searches. It directly reduces searches by reducing the chances that they lead to successful conviction, but it also indirectly increases them by increasing crime. If its indirect effect dominates, the rule actually increases searches and has an ambiguous effect on wrongful searches. If its direct effect dominates, it reduces wrongful searches, thereby protecting privacy. Its direct effect is more likely to dominate the greater is the number of police officers per capita, the lower is the police's incentive to simply close cases and the more accountable the police are for their mistakes. Police accountability also increases crime but unambiguously reduces wrongful searches. We also explore the effects of long-term progress in search technology on crime and privacy.

Coerced Confessions: Self-Policing in the Shadow of the Regulator

Short, J. L., Toffel, M. W. — 2008-03-04

As part of a recent trend toward more cooperative relations between regulators and industry, novel government programs are encouraging firms to monitor their own regulatory compliance and voluntarily report their own violations. In this study, we examine how regulatory enforcement activities influence organizations' decisions to self-police. We created a comprehensive data set for the "Audit Policy," a United States Environmental Protection Agency program that encourages companies to self-disclose violations of environmental laws and regulations in exchange for reduced sanctions. We find that facilities are more likely to self-disclose if they were recently subjected to one of several different enforcement measures and if they were provided with immunity from prosecution for self-disclosed violations.

Evidentiary Arbitrage: The Fabrication of Evidence and the Verifiability of Contract Performance

Sanchirico, C. W., Triantis, G. — 2008-03-04

The design of legal obligations, whether by a public body such as a legislature or by private contract, should anticipate the enforcement process that induces compliance. Judicial enforcement is costly and imperfect, largely because of limits on the court's ability to detect facts accurately. In adversarial litigation, courts are often fooled by fabricated, suppressed, or otherwise manipulated evidence. Given that fabricated evidence is both more costly and less valuable than truthful evidence, one would think that contracting parties should design their agreement so as to deter future evidence fabrication. To the contrary, this article suggests that evidence fabrication may be harnessed by contracting parties to improve the (evidentiary) cost-efficiency of performance incentives in their relationship. This paper thereby addresses the concept of verifiability in contract theory, the puzzling tolerance of the adjudicatory system for fabrication, and the incentives to fabricate created by thresholds in burdens of proof.

Ministerial Weights and Government Formation: Estimation Using a Bargaining Model

Adachi, T., Watanabe, Y. — 2008-03-04

This article proposes a method to estimate relative ministerial weights in parliamentary democracies. Specifically, we present a bargaining model of government formation and estimate structural parameters of the model using data for (i) who the formateurs are, (ii) what each party's voting weight is, and (iii) what ministerial seats each party obtains. We also measure the effects of voting weights and formateur advantage on bargaining results. We apply our proposed method to the case of Japan. Our estimation results show that political players value pork-related posts (such as the Minister of Construction) much more than prestigious ones (such as the Minister of Foreign Affairs). We also find that there is a significant formateur advantage, whereas voting weights do not have a significant scale effect, which is consistent with the findings for European democracies.

Optimal Contracts When a Worker Envies His Boss

Dur, R., Glazer, A. — 2008-03-04

A worker's utility may increase with his income, but envy can make his utility decline with his employer's income. This article uses a principal-agent model to study profit-maximizing contracts when a worker envies his employer. Envy tightens the worker's participation constraint and so calls for higher pay and/or a softer effort requirement. Moreover, a firm with an envious worker can benefit from profit sharing, even when the worker's effort is fully contractible. We discuss several applications of our theoretical work: envy can explain why a lower-level worker is awarded stock options, why incentive pay is lower in nonprofit organizations, and how governmental production of a good can be cheaper than private production.

Relational Contracts, Multitasking, and Job Design

Schottner, A. — 2008-03-04

This article analyzes optimal job design in a repeated principal-agent relationship when there is only one contractible and imperfect performance measure for three tasks whose contribution to firm value is nonverifiable. The tasks can be assigned to either one or two agents. Assigning an additional task to an agent strengthens his relational contract. Therefore, broad task assignments are optimal when the performance measure strongly distorts incentives for the two-task job. This is more likely to be the case if these two tasks are substitutes.

A Theory of Brinkmanship, Conflicts, and Commitments

Schwarz, M., Sonin, K. — 2008-03-04

Many conflicts and negotiations can be viewed as dynamic games in which parties have no commitment power. In our model, a potential aggressor demands concessions from a weaker party by threatening war. The absence of commitment makes a continuous stream of transfers a more effective appeasement strategy than a lump-sum transfer. As long as both sides have constant marginal utility of consumption, it is possible to construct a self-enforcing peace agreement even if transfers shift the balance of power. When marginal utility of consumption is decreasing, a self-enforcing peace agreement may not be feasible. The bargaining power of the potential aggressor increases dramatically if she is able to make probabilistic threats, for example, by taking an observable action that leads to war with a positive probability. This "brinkmanship strategy" allows a blackmailer to extract a positive stream of payments from the victim, even if carrying out the threat is harmful to both parties. Our results are applicable to environments ranging from diplomacy to negotiations within or among firms and are aimed to bring together "parallel" investigations in the nature of commitment in economics and political science.

Commitment, Exchange Autonomy, and the Boundary of the Hierarchical Firm

Levy, N. — 2008-03-04

In this article, I present a theory of the boundary of the firm that accounts for some important characteristics of real-world multidivisional firms: operative decisions are in the hands of middle managers who are rewarded based on the performance of their units, managers' decisions are subject to approval and intervention by the top management of the firm, and managers are better informed regarding the affairs of their divisions. In this setup, the integration of an intermediate input supplier and its buyer as separate divisions within a single firm is desirable, as long as the choice of trading partners can be credibly delegated to the divisions' managers. I show that this is satisfied not only under the assumption of full commitment by the general office of the firm but also, remarkably, if it has no commitment power whatsoever. An explanation of the boundary of the firm emerges only if the general office retains some limited commitment power. I show that the general office mandates internal trades in more instances than would have been optimal with full commitment, adversely affecting the levels of investment undertaken by the divisions' managers. In such cases, it can be optimal to have the trade conducted between nonintegrated parties.

Competition, Contractibility, and the Market for Donors to Nonprofits

Castaneda, M. A., Garen, J., Thornton, J. — 2008-03-04

This article investigates theoretically and empirically the effects of competition for donors on the behavior of nonprofit organizations. Theoretically, we consider a situation in which nonprofit organizations use donations to produce some commodity, but the use of donations is only partially contractible. The main results of the model indicate that an increase in competition (i) decreases the fraction of donations allocated to perquisite consumption and (ii) increases the fraction of donations allocated to promotional expenditures. Moreover, the effects of competition are magnified by the ability to contract on the use of donations. These hypotheses are tested with data on the expenditures of nonprofit organizations in a number of subsectors where competition is primarily local. We use across–metropolitan statistical areas' variation to measure differences in competition and proxy contractibility by the importance of tangible assets, which are more easily observed by donors. The estimated effects of competition and contractibility are consistent with our model.

Fee-Shifting Rules in Litigation with Contingency Fees

Chen, K.-P., Wang, J.-S. — 2007-08-22

This article theoretically compares the British and American fee-shifting rules in their influences on the behavior of the litigants and the outcomes of litigation. We build up a comprehensive litigation model with asymmetric information and agency costs, which makes it possible to make comparison on a broad arrays of issues in a single unified framework. We then solve for the equilibria under both American and British rules, and thereby compare their equilibrium settlement amounts and rates, expenditures incurred in trials, as well as the plaintiff's chances of winning and incentive to sue. The theoretical results are broadly consistent with existing empirical evidence.

Bargaining over an Uncertain Value: Arbitration Mechanisms Compared

Deck, C. A., Farmer, A. — 2007-08-22

This article explores the theoretical and behavioral impact of conventional arbitration and final-offer arbitration (FOA) when parties are bargaining over an uncertain value. In this context, one player receives a fixed payment while the other player receives the uncertain residual. Although both forms of arbitration have identically sized contract zones, we show theoretically that in FOA the contract zone shifts in favor of the residual claimant. In addition, as the variance of the possible values rises, the contract zone shifts further in favor of the residual claimant. In laboratory testing, the contract zone roughly reflects the central tendencies of behavior; however, both forms of arbitration increase conflict relative to a no-arbitration baseline. This is caused by residual claimants being more aggressive when arbitration is available while fixed-payment recipients are not. However, both parties play a role in the conflict escalation due to the increased proposal variation.

The Effect on Divorce of Legislated Net-Wealth Transfers

Allen, D. W. — 2007-08-22

In recent years, legislatures have imposed several types of guidelines restricting court discretion. Guidelines designed around "average" cases, however, can lead to problems for "nonaverage" situations. In the context of divorce, poorly designed child support guidelines may create an opportunity for a net-wealth transfer in excess of the costs of children for "nonaverage" families and therefore create an incentive to divorce. This incentive to divorce, when coupled with the ability to divorce under no-fault laws, may lead to higher divorce rates for certain classes of couples. This article exploits the 1997 Canada Child Support Guidelines to test the divorce prediction using data from the Survey of Labour Income Dynamics. I find separation rates increase after implementation of the Guidelines among couples with income of $25,000 per year.

Do the Merits Matter Less After the Private Securities Litigation Reform Act?

Choi, S. J. — 2007-08-22

This study provides evidence on the impact of the Private Securities Litigation Reform Act (PSLRA) of 1995. Others have furnished evidence that the PSLRA increased the significance of merit-related factors in determining the incidence and outcomes of securities fraud class actions. This increase is consistent with two hypotheses. First, the PSLRA may have reduced solely the incidence of nuisance litigation. Second, the PSLRA may have also reduced meritorious claims where the additional costs imposed by the PSLRA made such claims unprofitable from the perspective of plaintiffs' attorneys. The study provides evidence that pre-PSLRA nonnuisance claims lacking obvious "hard evidence" indicia of fraud (an accounting restatement or Securities and Exchange Commission action) would have faced (1) a lower probability of suit in the post-PSLRA period and (2) a greater likelihood of receiving a dismissal or low-value settlement in the post-PSLRA period.

Do the Merits Matter More? The Impact of the Private Securities Litigation Reform Act

Johnson, M. F., Nelson, K. K., Pritchard, A. — 2007-08-22

This article examines the effect of the Private Securities Litigation Reform Act of 1995 (PSLRA) on stockholder lawsuits. We explore the role of restatements, earnings forecasts, and insider trading in the filing and resolution of lawsuits for a sample of high technology firms. Consistent with our predictions, there is a post-PSLRA shift away from litigation based on forward-looking earnings disclosures. Conversely, there is a significantly greater correlation between litigation and both earnings restatements and abnormal insider selling after the PSLRA. Finally, we find a post-PSLRA increase in the likelihood of settlement for cases involving earnings restatements.

A Damage-Revelation Rationale for Coupon Remedies

Polinsky, A. M., Rubinfeld, D. L. — 2007-08-22

This article studies optimal remedies in a setting in which damages vary among plaintiffs and are difficult to determine. We show that giving plaintiffs a choice between coupons to purchase units of the defendant's product at a discount and cash—a coupon-cash remedy—is superior to cash alone. The optimal coupon-cash remedy offers a cash amount that is less than the value of the coupons to plaintiffs who suffer relatively high harm. Such a remedy induces these plaintiffs to choose coupons, and plaintiffs who suffer relatively low harm to choose cash. Sorting plaintiffs in this way leads to better deterrence because the costs borne by defendants (the cash payments and the cost of providing coupons) more closely approximate the harms that they have caused.

Courts of Law and Unforeseen Contingencies

Anderlini, L., Felli, L., Postlewaite, A. — 2007-08-22

We study a contracting model with unforeseen contingencies in which the court is an active player. Ex ante, the contracting parties cannot include the risky unforeseen contingencies in the contract they draw up. Ex post, the court observes whether an unforeseen contingency occurred and decides whether to void or uphold the contract. If the contract is voided by the court, the parties can renegotiate a new agreement ex post. There are two effects of a court that voids contracts. The parties' incentives to undertake relationship-specific investment are reduced, and the parties enjoy greater insurance against the unforeseen contingencies that the ex ante contract cannot account for. In this context, we fully characterize the optimal decision rule for the court. The behavior of the optimal court is determined by the trade-off between the need for incentives and the gains from insurance that voiding in some circumstances offers to the agents.

Agency Structure and Firm Culture: OSHA, EPA, and the Steel Industry

Deily, M. E., Gray, W. B. — 2007-08-22

We compare models of Occupational Safety and Health Administration (OSHA) and Environmental Protection Agency (EPA) enforcement and compliance for steel plants during the 1980s. We find that OSHA and EPA respond similarly to plant-level compliance and measures of hazardousness, but differently to firm-level compliance and risks of plant closing, and we relate the differences to the agencies' differing organizational structures. Plant-level compliance is affected by enforcement pressure, compliance costs, and the firm's overall compliance behavior in similar ways for the two regulatory areas, but environmental compliance was also sensitive to plant size and risk of closing. Finally, we find that the likelihood that a plant was in compliance with one agency seemed at most weakly related to whether it was in compliance with the other, but that plants likely to receive enforcement attention from one agency were also more likely to receive enforcement attention from the other agency.

Sale-Backs in Bankruptcy

Povel, P., Singh, R. — 2007-08-22

When bankrupt firms are sold, they are often repurchased by their former owner or manager. These insiders are by default better informed than outsiders about the true value of the firm or its assets, so other potential buyers must worry about overpaying if they win. The presence of insiders may thus have a chilling effect on the bidding. We ask how insiders should be treated in bankruptcy sales: Should they be allowed to submit bids? If so, under what conditions? We derive properties of an optimal sale procedure and show that it must be biased against insiders. Specifically, it should be harder for insiders to win with low bids than for outsiders. We show that the "market tests" that are routinely required in bankruptcy sales are suboptimal since they treat all potential buyers alike and forgo the benefits of biasing the procedure against insiders.

Motivating Through Delegating Tasks or Giving Attention

Swank, O. H., Visser, B. — 2007-08-22

An important role of managers is to motivate subordinates. Monetary rewards have been the focus of economic analysis. Managers also use other means to influence subordinates. If a manager can better assess the subordinate's ability than the subordinate himself, and if ability and effort are complements, the manager finds it hard not to overstate a junior's ability. Talk is cheap. We analyze under what conditions a manager can use organizational practices such as delegation and the selective provision of attention to credibly communicate his assessment. We compare their desirability. Delegation is preferable in case the manager's assessment is fairly accurate; attention is inescapable if it is inaccurate.

Cultural Inertia and Uniformity in Organizations

Carrillo, J. D., Gromb, D. — 2007-08-22

We analyze aspects of the structure of organizational culture. We show that old and culturally uniform organizations are prone to cultural inertia, that is, they are reluctant to adopt a different culture in response to a change in the environment. Cultural uniformity can be beneficial because the associated inertia ex post protects and therefore ex ante encourages culture-specific investments by agents. We also explore the model's implications for such issues as cultural uniformity within an organization, cultural heterogeneity across organizations, the destabilizing effect of growth and mergers, and the conflicts arising in the management of culture.

Acknowledgments

2007-08-22

Introductory Note

2007-06-26

Bargaining and Opinion Assignment on the US Supreme Court

Lax, J. R., Cameron, C. M. — 2007-06-26

We formulate a new game-theoretic model of bargaining on the US Supreme Court. In the model, a degree of monopoly power over policy endogenously accrues to the assigned writer despite an "open rule" permitting other justices to make counteroffers. We assume justices are motivated ultimately by a concern for judicial policy, but that the policy impact of an opinion depends partly on its persuasiveness, clarity, and craftsmanship—its legal quality. The effort cost of producing a high-quality opinion creates a wedge that the assignee can exploit to move an opinion from the median without provoking a winning counteroffer. We use this bargaining model as the foundation for a formal analysis of opinion assignment. Both the bargaining and opinion assignment models display rich and tractable comparative statics, allowing them to explain well-known empirical regularities, as well as to generate new propositions, all within a unified and internally consistent framework.

The Judicial Common Space

Epstein, L., Martin, A. D., Segal, J. A., Westerland, C. — 2007-06-26

To say that positive political theory (PPT) scholarship on the hierarchy of justice is theory rich and data poor is to make a rather uncontroversial claim. For over a decade now, scholars have offered intriguing theoretical accounts aimed at understanding why lower courts defy (comply with) higher courts. But only rarely do they subject the accounts to rigorous empirical interrogation. The chief obstacle, it seems, is the lack of a reliable and valid measurement strategy for placing judges of lower courts and justices of higher courts in the same policy space. Without such a strategy, we can systematically test few, if any, hypotheses flowing from PPT models of the judicial hierarchy. With such an approach not only can we investigate the implications of these models, we can assess many others flowing from the larger PPT program on judging, as well. It is to the challenge of scaling judges and justices (as well as legislatures and executives) that we turn in this article. We begin by explicating our measurement strategy, and then by explaining its advantages over previous efforts. Next we explore the results of our approach and provide a descriptive look at data it yields: a "Judicial Common Space" (JCS) score for all justices and judges appointed since 1953. The last section offers three applications designed to shore up the suitability and adaptability of the JCS for a range of positive projects on the courts.

Legal Doctrine and Political Control

Jacobi, T., Tiller, E. H. — 2007-06-26

We model legal doctrine as an instrument of political control by higher courts over lower courts and the case outcomes they produce. We focus on the choice between determinate and indeterminate doctrines within a hierarchy of courts where political–ideological alignment between lower and higher courts varies. We show that the choice over doctrinal determinacy depends on the distribution of cases, the distribution of litigants, judicial types, and the level of policy alignment between higher and lower court judges. The model suggests the optimal doctrinal choice for a high court, given the political–ideological alignment between the high court and the lower court, the control characteristics of doctrines themselves, and the matching of doctrines to litigant pools. This has implications regarding preference divergence within the judicial hierarchy, the interaction of different doctrines, and interplay between doctrinal specificity and doctrinal reach.

Presidents, Justices, and Deference to Administrative Action

Smith, J. L. — 2007-06-26

This article examines the effect of the relationship between the president and Supreme Court Justices on justices' voting in administrative law cases. I evaluate Cohen and Spitzer's theory that justices tailor the pro- or antideference signal sent to the lower courts based on their relationship with the sitting president. The results show, contrary to the theory of Cohen and Spitzer, that justices' votes in administrative law cases are influenced by the ideology of the president under whom the administrative decisions were made rather than by the ideology of the president in office at the time of the Court's decision.

Assessing Preference Change on the US Supreme Court

Martin, A. D., Quinn, K. M. — 2007-06-26

The foundation upon which accounts of policy-motivated behavior of Supreme Court justices are built consists of assumptions about the policy preferences of the justices. To date, most scholars have assumed that the policy positions of Supreme Court justices remain consistent throughout the course of their careers and most measures of judicial ideology—such as Segal and Cover scores—are time invariant. On its face, this assumption is reasonable; Supreme Court justices serve with life tenure and are typically appointed after serving in other political or judicial roles. However, it is also possible that the worldviews, and thus the policy positions, of justices evolve through the course of their careers. In this article we use a Bayesian dynamic ideal point model to investigate preference change on the US Supreme Court. The model allows for justices' ideal points to change over time in a smooth fashion. We focus our attention on the 16 justices who served for 10 or more terms and completed their service between the 1937 and 2003 terms. The results are striking—14 of these 16 justices exhibit significant preference change. This has profound implications for the use of time-invariant preference measures in applied work.

Directing Retribution: On the Political Control of Lower Court Judges

Huber, G. A., Gordon, S. C. — 2007-06-26

The sentencing decisions of trial judges are constrained by statutory limits imposed by legislatures. At the same time, judges in many states face periodic review, often by the electorate. We develop a model in which the effects of these features of a judge's political landscape on judicial behavior interact. The model yields several intriguing results: First, if legislators care about the proportionality of punishment, judicial discretion increases with their punitiveness. Second, voters are limited by two factors in their ability to make inferences about judicial preferences based on observed sentences: the extent to which judges are willing to pander to retain office and the range of judicial discretion mandated by the legislature. Finally, legislators can sometimes manipulate judicial discretion to aid sufficiently like-minded voters in their efforts to replace ideologically dissimilar judges.

Panel Composition and Judicial Compliance on the US Courts of Appeals

Kastellec, J. P. — 2007-06-26

This article integrates the literatures on judicial compliance, panel decision making, and case selection in the federal judiciary hierarchy. Many studies have speculated that "panel effects"—the phenomena under which an individual judge's vote may depend on her colleagues on a three-judge panel—can be tied to a "whistleblower effect," through which a lower court judge can constrain a panel majority from disobeying with Supreme Court precedent by threatening to dissent. However, no study has systematically found such a relationship. I present a game-theoretic model of circuit court-Supreme Court interaction that demonstrates how panel composition might affect the likelihood of lower court compliance to Supreme Court doctrine. The model illustrates how three-judge panels, while not inducing perfect doctrinal control of lower courts by the Supreme Court, significantly increases the latter's ability to see its preferred doctrine carried out by its subordinates in the judicial hierarchy.

Resurrecting Lochner: A Defense of Unprincipled Judicial Activism

Rogers, J. R., Vanberg, G. — 2007-06-26

Lochner v. New York, 198 U.S. 45 (1905), stands as one of the Supreme Court's most reviled decisions. We challenge the critical consensus against Lochner and provide a defense, albeit a contingent defense, of "unprincipled" judicial activism. To do so, we develop a game-theoretic model of judicial–legislative interaction. We use the model to compare outcomes generated in a system of legislative supremacy to outcomes generated in a system in which judicial review is provided by a legally unprincipled, activist judiciary. We show that judicial review, even when provided by an activist, politicized judiciary, can promote important constitutional values and improve legislative quality relative to a deferential judiciary. In doing so, we identify an important "passive" component to the effect that judicial review has on legislatures and on legislation. Finally, we demonstrate that the addition of other institutions and constraints on judicial behavior amplify the beneficial effects that judicial review provides to the legislative process.

Bureaucratic Decision Costs and Endogenous Agency Expertise

Stephenson, M. C. — 2007-06-26

This article analyzes the effect of the cost that an agency must incur to adopt a new regulation (the "enactment cost") on the agency's incentive to invest in expertise. The effect of the enactment cost on agency expertise depends on whether the agency would regulate if it fails to acquire additional information about the regulation's effects. If an uninformed agency would regulate, increasing enactment costs increases agency expertise; if an uninformed agency would retain the status quo, increasing enactment costs decreases agency expertise. These results may influence the behavior of an uninformed overseer, such as a court or legislature, that can manipulate the agency's enactment costs. Such an overseer must balance its interest in influencing agency policy preferences against its interest in increasing agency expertise. The article discusses the implications of these results for various topics in institutional design, including judicial and executive review of agency regulations, structure-and-process theories of congressional oversight, national security, criminal procedure, and constitutional law.

Estimating the Effect of Redistricting on Minority Substantive Representation

Epstein, D., Herron, M. C., O'Halloran, S., Park, D. — 2007-06-26

This article applies modern Bayesian roll call analysis to estimate legislators' support for minority-favored policies, and to determine the likely impact of competing redistricting plans on the substantive representation of minority interests. We first provide a theory of districting and policy outcomes that points to the importance of coalition building in advancing minority policy concerns and motivates our estimation techniques. We then apply this methodology to the redistricting of the South Carolina State Senate following the 1990 census. We show that this redistricting led to more minorities being elected to office but less substantive representation.