Law and Economics

Members of the NBER's Law and Economics Program met February 28 in Cambridge. Program Director Christine Jolls of Yale University organized the meeting. These researchers' papers were presented and discussed:

Allen Ferrell, Harvard University and NBER; Alberto Manconi, Bocconi University; Ekaterina V. Neretina, University of Southern California; Luc Renneboog, Tilburg University; and William Powley, MIT

Are Star Lawyers also Better Lawyers?

Ferrell, Manconi, Neretina, Renneboog, and Powley study the performance of dominant plaintiff law firms ("stars") in litigation brought against publicly traded corporations. The researchers use insurance coverage as a benchmark for expected settlement amounts, to separate to what extent (a) stars reach more favorable settlements on any lawsuit (a performance or treatment effect) or (b) stars are retained in lawsuits where a favorable settlement is ex ante more likely (a selection effect). Their findings indicate the latter, and that star firms have an economically small impact on settlement amounts. This result is not explained by measurement error or over-/under-insurance. The extent to which stars are associated with improvements in corporate governance also appears limited. The stars' large market share and the high fees they earn may be justified by their ability to reduce uncertainty about the lawsuit outcome or by frictions, such as aggressive marketing and limited client sophistication and bargaining power, which limits the stars' clients' ability to turn to other law firms.

Alberto Galasso, University of Toronto and NBER, and Hong Luo, Harvard University

Risk-Mitigating Technologies: the Case of Radiation Diagnostic Devices (NBER Working Paper No. 26305)

Galasso and Luo study the impact of consumers' risk perception on firm innovation. Their analysis exploits a major surge in the perceived risk of radiation diagnostic devices, following extensive media coverage of a set of over-radiation accidents involving CT scanners in late 2009. Difference-indifferences regressions using data on patents and FDA product clearances show that the increased perception of radiation risk spurred the development of new technologies that mitigated such risk and led to a greater number of new products. The researchers provide qualitative evidence and describe patterns of equipment usage and upgrade that are consistent with this mechanism. Their analysis suggests that changes in risk perception can be an important driver of innovation and can shape the direction of technological progress.

Ofer Eldar and Jill Grennan, Duke University, and Kate Waldock, Georgetown University

Common Ownership and Startup Growth

Is common ownership anticompetitive or do firms benefit when the same investors hold stakes in competing firms? Eldar, Grennan, and Waldock exploit a quasi-natural experiment in the venture capital (VC) industry -- the staggered introduction of exemptions from liability when investors pursue conflicting business opportunities -- as a shock to common ownership. The researchers find increases in same-industry investment and directorships held at competing startups. Despite potential conflicts from information sharing, commonly held startups benefit by raising more capital through more investment rounds. Evidence from VC funds' returns and startups' exits suggests common ownership helps weaker startups improve rather than biasing competition toward winners.

Li Liao, Zhengwei Wang, and Jia Xiang, Tsinghua University, and Hongjun Yan, DePaul University; and Jun Yang, Indiana University

Investing with Fast Thinking

Using data from a major online peer-to-peer lending market, Liao, Wang, Xiang, Yan, and Yang document that investors appear to follow a simple decision rule: they focus on loans with high interest rates, disregarding information on credit ratings. Their empirical and experimental analyses uncover three factors that shape the decision rule: time pressure (the stronger the time pressure, the more reliance on interest rates), salience (investors pay more attention to default risks when credit ratings are made more salient on the investment platform), and firsthand experience (investors respond to the defaults of their own loans more strongly than the defaults of peer investors' loans).

Giri Parameswaran, Haverford College; Charles Cameron, Princeton University; and Lewis A. Kornhauser, New York University School of Law

Bargaining and Strategic Voting on Appellate Courts

Parameswaran, Cameron, and Kornhauser explore the properties of voting rules and procedures employed by appellate courts in the US. Our model features: (1) a two-stage decision-making process (first over case disposition, then over majority opinion content), (2) dispositional consistency (the new rule must yield the Court's indicated case disposition when applied to the instant case), (3) restricted bargaining entrée (only members of the winning dispositional coalition bargain over policy), (4) competitive offers (potentially many competitive majority opinions), and (5) absolute majority in joins (a majority of the court must endorse the rule in the majority opinion if it is to have precedential power). The researchers show that the median judge is pivotal over case dispositions, although she (and others) may not vote sincerely. Strategic voting becomes more likely as the location of the case becomes more extreme, resulting in majority coalitions that give the appearance of less polarization on the court, than is truly the case. The equilibrium policy depends on the composition of the dispositional majority, and generically does not coincide with the ideal policy of the median judge either in the dispositional majority or the bench as a whole. Rather, opinions are drawn toward a weighted center of the dispositional majority but often reflect the preferences of the opinion author.

David Frydlinger, Cirio Law Firm, and Oliver D. Hart, Harvard University and NBER

Overcoming Contractual Incompleteness: The Role of Guiding Principles (NBER Working Paper No. 26245)

Frydlinger and Hart consider a buyer and seller who contract over a service. The contract encourages investment and provides a reference point for the transaction. In normal times the contract works well. But with some probability an abnormal state occurs and the service must be modified. The parties expect each other to behave "reasonably", but given self-serving biases their views of reasonableness may not coincide, leading to aggrievement and deadweight losses. The adoption by the parties of guiding principles such as loyalty and equity in their contract can help. The researchers provide supporting evidence in the form of case studies and interviews.

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