Law and Economics

March 3, 2017
Christine Jolls of Yale University, Organizer

David Arnold, Princeton University; Will S. Dobbie, Princeton University and NBER; and Crystal Yang, Harvard University

Racial Bias in Bail Decisions

This paper develops a new test for identifying racial bias in the context of bail decisions — a high-stakes setting with large disparities between white and black defendants. Arnold, Dobbie, and Yang motivate their analysis using a simple model that predicts that, unless bail judges are racially biased, rates of pre-trial misconduct will be identical for marginal white and marginal black defendants. In contrast, marginal white defendants will have a higher probability of misconduct than marginal black defendants if bail judges are racially biased. To test the model, the researchers develop a new estimator that uses the release tendencies of quasi-randomly assigned bail judges to identify the relevant race-specific misconduct rates. Estimates from Miami and Philadelphia show that bail judges are racially biased against black defendants, with substantially more racial bias among both inexperienced and part-time judges. The researchers also find descriptive evidence that experienced and inexperienced judges place different weight on other, non-race characteristics that predict misconduct. They argue that these results are consistent with a model of on-the-job learning where racial bias decreases as judges adjust the predictive weight they place on the most salient observable defendant characteristics such as race.

A. Mitchell Polinsky, Stanford University and NBER, and Paul N. Riskind, Stanford Law School

Deterrence and the Optimal Use of Prison, Parole, and Probation

In this article Polinsky and Riskind derive the sentence — choosing from among the sanctions of prison, parole, and probation — that achieves a target level of deterrence at least cost. Potential offenders discount the future disutility of sanctions and the state discounts the future costs of sanctions. Prison has higher disutility and higher cost per unit time than parole and probation, but the cost of prison per unit of disutility can be lower or higher than the cost of parole and probation per unit of disutility. The optimal order of sanctions depends on the relative discount rates of potential offenders and the state, and the optimal duration of sanctions depends on the relative costs per unit of disutility among the sanctions and on the target level of deterrence. The researchers focus on the case in which potential offenders discount the disutility of sanctions at a higher rate than the state discounts the costs of sanctions. In this case, if prison is more cost-effective than parole and probation — that is, has a lower cost per unit of disutility — prison should be used exclusively. If prison is less cost-effective than parole and probation, probation should be used if the deterrence target is low enough, and prison followed by parole should be used if the deterrence target is relatively high. Notably, it may be optimal to employ a prison term even if prison is less cost-effective than parole and probation and even if prison is not needed to achieve the target level of deterrence, because of what the researchers refer to as the front-loading advantage of imprisonment.

Special Session on Consumer/Household Finance

Saurabh Bhargava and George Loewenstein, Carnegie Mellon University, and Justin R. Sydnor, University of Wisconsin at Madison and NBER

Evaluating Health Insurance Decisions: Evidence from a Menu with Dominated Options

Bhargava, Loewenstein, and Sydnor examine the health plan choices that 23,897 employees at a U.S. firm made from a large menu of options that differed only in financial cost-sharing and premium. These decisions provide a clear test of the predictions of the standard economic model of insurance choice in the absence of choice frictions because plans were priced so that nearly every plan with a lower deductible was financially dominated by an otherwise identical plan with a high deductible. The researchers document that the majority of employees chose dominated plans, which resulted in excess spending equivalent to 24% of chosen plan premiums. Low-income employees were significantly more likely to choose dominated plans, and most employees did not switch into more financially efficient plans in the subsequent year. The researchers show that the choice of dominated plans cannot be rationalized by standard risk preference or any expectations about health risk. Testing alternative explanations with a series of hypothetical-choice experiments, they find that the popularity of dominated plans was not primarily driven by the size and complexity of the plan menu, nor informed preferences for avoiding high deductibles, but by employees’ lack of understanding of health insurance. The findings challenge the standard practice of inferring risk preferences from insurance choices, and raise doubts about the welfare benefits of health reforms that expand consumer choice.

Tal Gross, Columbia University and NBER; Matthew J. Notowidigdo, Northwestern University and NBER; and Jialan , University of Illinois at Urbana-Champaign

The Marginal Propensity to Consume Over the Business Cycle (NBER Working Paper No. 22518)

This paper estimates how the marginal propensity to consume (MPC) varies over the business cycle by exploiting exogenous variation in credit card borrowing limits. Ten years after an individual declares Chapter 7 bankruptcy, the record of the bankruptcy is removed from her credit report, generating an immediate and persistent increase in credit score. Gross, Notowidigdo and Wang study the effects of "bankruptcy flag" removal using a sample of over 160,000 bankruptcy filers whose flags were removed between 2004 and 2011. Authorse document that in the year following flag removal, credit card limits increase by $780 and credit card balances increase by roughly $290, implying an "MPC out of liquidity" of 0.37. They find a significantly higher MPC during the Great Recession, with an average MPC roughly 20–30 percent larger between 2007 and 2009 compared to surrounding years. Gross, Notowidigdo and Wang find no evidence that the counter-cyclical variation in the average MPC is accounted for by compositional changes or by changes over time in the supply of credit following bankruptcy flag removal. These results are consistent with models where liquidity constraints bind more frequently during recessions.

Andrew Daughety and Jennifer Reinganum, Vanderbilt University

Information Suppression by Teams and Violations of the Brady Rule

Daughety and Reinganum develop a model of individual prosecutors (and teams of prosecutors) and show how, in equilibrium, team-formation can lead to increased incentives to suppress evidence (relative to those faced by a lone prosecutor). The researchers' model assumes that each individual prosecutor is characterized by a variable that captures that individual's level of tradeoff between a desire for career advancement (by winning a case) and a disutility for unjustly convicting an innocent defendant by suppressing exculpatory evidence. They assume a population of prosecutors that is heterogenous with respect to this tradeoff rate, and each individual's tradeoff rate is their own private information. A convicted defendant may later discover the exculpatory information; a judge will then void the conviction and may order an investigation. If the prosecutor is found to have violated the defendant's Brady rights (to exculpatory evidence), this results in penalizing the prosecutor. The payoff from winning a case is a public good (among the team members) while any penalties are private bads. The anticipated game between the prosecutors and the judge is the main focus of this paper. The decision to investigate a sole prosecutor, or a team of prosecutors, is determined endogenously. The researchers show that the equilibrium assignment of roles within the team involves concentration of authority about suppressing/disclosing evidence.

Albert Choi, University of Virginia, and Eric Talley, Columbia University

Appraising the "Merger Price" Appraisal Rule

Choi and Talley develop an analytic framework combining agency costs, auction design and shareholder voting to study how best to measure "fair value" for dissenting shareholders in a post-merger appraisal proceeding. The researchers' inquiry spotlights an approach recently embraced by some courts that benchmarks fair value against the merger price itself, at least in certain situations. As a general matter, the "Merger Price" (MP) rule tends to depress both acquisition prices and target shareholders' expected welfare relative to both the optimal appraisal policy and several other plausible alternatives. In fact, they demonstrate that the MP rule is strategically equivalent to nullifying appraisal rights altogether. Although the MP rule may be warranted in certain circumstances, the researchers' analysis suggests that such conditions are unlikely to be widespread and, consequently, the rule should be employed with caution. The framework also helps explain why a healthy majority of litigated appraisal cases using conventional fair-value measures result in valuation assessments exceeding the deal price — an equilibrium phenomenon that is an artifact of rational, strategic behavior (and not necessarily an institutional deficiency, as some assert). Finally, this analysis facilitates better understanding of the strategic and efficiency implications of recent reforms allowing "medium-form" mergers, as well as an assortment of (colorfully named) appraisal-related practices, such as blow provisions, drag-alongs, and "naked no-vote" fees.

Edward L. Glaeser and Andrei Shleifer, Harvard University and NBER, and Giacomo A.M. Ponzetto, CREI, Universitat Pompeu Fabra

Securing Property Rights 22701)

A central challenge in securing property rights is the subversion of justice through legal skill, bribery, or physical force by the strong — the state or its powerful citizens — against the weak. Glaeser, Ponzetto, and Shleifer present evidence that the less educated and poorer citizens in many countries feel their property rights are least secure. The researchers then present a model of a farmer and a mine which can pollute his farm in a jurisdiction where the mine can subvert law enforcement. They show that, in this model, injunctions or other forms of property rules work better than compensation for damage or liability rules. The equivalences of the Coase Theorem break down in realistic ways. The case for injunctions is even stronger when parties can invest in power. The researchers' approach sheds light on several controversies in law and economics, but also applies to practical problems in developing countries, such as low demand for formality, law enforcement under uncertain property rights, and unresolved conflicts between environmental damage and development.

Justin Marion, University of California Santa Cruz

Affirmative Action Exemptions and Capacity Constrained Firms

This paper studies how affirmative action exemptions in public procurement can improve efficiency and government expenditures without harming disadvantaged business enterprise (DBE) utilization. Marion examines a unique program employed by the Iowa Department of Transportation, where prior to 2013 prime contractors were allowed an exemption from a project’s affirmative action requirement if their history of DBE utilization was sufficiently high. Marion finds that prime contractors use the exemption to smooth demands on capacity constrained DBEs, building a history of utilization during low demand periods and exploiting the resulting exemption during high demand. The exemption policy was unexpectedly eliminated in 2013, which the researcher exploits to evaluate its effect on DBE utilization and procurement costs. He finds that average DBE utilization was unchanged and bids rose on affirmative action contracts.

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