Journal of Law, Economics, and Organization - recent issues

Editor's Note

Ayres, I. — 2009-03-30

Matching Bankruptcy Laws to Legal Environments

Ayotte, K., Yun, H. — 2009-03-30

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. (JEL D86, G33, G34, K22)

Sustaining Cooperation with Joint Ventures

Cooper, R. W., Ross, T. W. — 2009-03-30

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. (JEL L12, L41, K21)

A Principal-Agent Theory of En Banc Review

Clark, T. S. — 2009-03-30

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. More broadly, the theory and findings developed here have implications for strategic auditing in a political hierarchy. (JEL K40, D72)

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

Wickelgren, A. L. — 2009-03-30

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. (JEL C78, D1, D23, J12, J18, K3, K36)

Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis

Kamar, E., Karaca-Mandic, P., Talley, E. — 2009-03-30

This article investigates whether the passage and the implementation of the Sarbanes-Oxley Act of 2002 (SOX) drove firms out of the public capital market. To control for other factors affecting exit decisions, we examine the post-SOX change in the propensity of American public targets to be bought by private acquirers rather than public ones with the corresponding change for foreign public targets, which were outside the purview of SOX. Our findings are consistent with the hypothesis that SOX induced small firms to exit the public capital market during the year following its enactment. In contrast, SOX appears to have had little effect on the going-private propensities of larger firms. (JEL G30, G34, G38, K22)

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

Emons, W., Fluet, C. — 2009-03-30

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. (JEL D82, K41, K42)

An Economic Model of Whistle-Blower Policy

Heyes, A., Kapur, S. — 2009-03-30

"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. (JEL K42, K32)

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

Morantz, A. D. — 2009-03-30

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. (JEL D73, D78, H73, I18, J08, J28, J88, K00, K23, K31, K32, L51, and L74)

Optimal Vertical Arrangements When Resale Is Possible

Selvaggi, M. — 2009-03-30

This paper pinpoints optimal vertical arrangements in settings characterized by incomplete contracting and resale of an intermediate input (a "widget"). In the Grossman-Hart-Moore property rights theory, we conclude that sometimes strictly complementary assets should be owned separately to permit the emergence of a secondary market. In a richer model where the parties choose specific and nonspecific investments, vertical separation may also dominate joint ownership. The article then examines the profitability of three integration forms when the proposed bargaining model substitutes random-order values (e.g., the Shapley value). The conclusions differ markedly from existing claims. (JEL C70, C78, D23, L42)

Least-Cost Avoidance: The Tragedy of Common Safety

Dari-Mattiacci, G., Garoupa, N. — 2009-03-30

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. (JEL K13, K32)

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

Franck, R. — 2009-03-30

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, K40)

Corporate Boards of Directors: In Principle and in Practice

Williamson, O. E. — 2008-09-02

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. (JEL G30, G34, K22, L14)

Incentives in Markets, Firms, and Governments

Acemoglu, D., Kremer, M., Mian, A. — 2008-09-02

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. (JEL D23, L22, H10, H52)

Urban Extremism

Brueckner, J. K., Glazer, A. — 2008-09-02

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. (JEL H70, H41, D72)

An Economic Analysis of Color-Blind Affirmative Action

Fryer, R. G., Loury, G. C., Yuret, T. — 2008-09-02

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.

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

Mittendorf, B. — 2008-09-02

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. (JEL J33, M14, M52)

Democracy, Credibility, and Clientelism

Keefer, P., Vlaicu, R. — 2008-09-02

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. (JEL D720, H110, H300, H400, H500, O100)

Trust in Transition: Cross-Country and Firm Evidence

Raiser, M., Rousso, A., Steves, F., Teksoz, U. — 2008-09-02

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. (JEL D23, D92, P26, P31, Z13)

Environmental Liability in Transboundary Harms: Law and Forum Choice

Eckert, A., Smith, R. T., van Egteren, H. — 2008-09-02

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. (JEL K32, Q5)

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

Garoupa, N., Gomez-Pomar, F. — 2008-09-02

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. (JEL J4, K1, K2, K4)

Bureaucratic Rents and Life Satisfaction

Luechinger, S., Meier, S., Stutzer, A. — 2008-09-02

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. (JEL D72, D73, I31, J30, J45)

Acknowledgments

2008-09-02

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.