Law and Economics

February 20, 2015
Christine Jolls of Yale Law School, Organizer

Victor Calanog, University of Pennsylvania; Megan Lawrence, Harvard University; and Felix Oberholzer-Gee, Harvard University and NBER

Bidding for Business: Tax Discrimination as Local Industrial Policy

Local and state governments routinely compete for economic activity by offering firms tax breaks and subsidies. While empirical evidence shows that large industrial plants produce significant local benefits, little is know about the type of firm that local governments most seek to attract. To further the understanding of local tax discrimination, Lawrence, Oberholzer-Gee, and Calanog conduct a randomized field experiment across 312 communities in the United States. The researchers observe how each of the governments in their sample adjusts its property tax in response to variation in firm characteristics and local economic conditions. They find that towns pursue a systematic local industrial policy whose goal is to attract manufacturing jobs and work for unskilled labor. Surprisingly, the researchers find no evidence that towns seek to generate rents targeted at the current local population. Local tax policy also appears to disregard agglomeration effects and concerns over industrial diversification.

Bradley Larsen, Stanford University and NBER

Occupational Licensing and Quality: Distributional and Heterogeneous Effects in the Teaching

In this paper, Larsen examines a common form of entry restriction: occupational licensing. The paper studies two questions: first, how occupational licensing laws affect the distribution of quality, and second, how the effects of licensing on quality vary across regions of differing income levels. The paper uses variation in state licensing requirements for teachers and two national datasets on teacher qualifications and student outcomes from 1983-2008. Two measures of quality are used: the qualifications of candidates entering the occupation (input quality) and the quality of service provided (output quality). Results show that more restrictive licensing laws - in the form of certification tests required for initial licensure - may lead some first-year teachers of high input quality to opt out of the occupation. In the sample of teachers who remain in the occupation multiple years, stricter licensing appears to increase input quality at most quantiles of the teacher quality distribution. Output quality, as measured by student test scores, also changes with stricter occupational licensing, revealing a widening of the distribution. For most forms of licensing studied, input and output quality improvements due to stricter licensing requirements occur in high-income rather than low-income school districts.

Lauren Cohen, Harvard University and NBER; Umit G. Gurun, University of Texas, Dallas; and Scott Duke Kominers, Harvard University

Patent Trolls: Evidence from Targeted Firms (NBER Working Paper 20322)

Kathryn Spier, Harvard University and NBER, and J.J. Prescott, University of Michigan

Tailored Suits: Contracting on Litigation

A plaintiff and defendant are negotiating in the shadow of pending litigation. When the divergence between their subjective beliefs is sufficiently large, and they are not too risk averse, Spier and Prescott find that the litigants will forego settlement in favor of a contract that tailors the damage payments to suit their beliefs and preferences. With CARA expected utility, the optimal contract is increasing in the likelihood ratio of their subjective beliefs. When the litigants' beliefs are normally distributed with divergent means, the optimal contract is linear in the court's award and is flatter when the parties are more risk averse, when beliefs are more aligned, when the trial outcome variance is larger, and when litigation costs are endogenous. Implications for real world litigation practice include the use of high-low settlement agreements and partial settlement in multi-issue litigation. Finally, the role of third parties, including litigation funders and insurance companies, is analyzed and discussed.

Will S. Dobbie, Princeton University and NBER, and Paul Goldsmith-Pinkham and Crystal Yang, Harvard University

Consumer Bankruptcy and Financial Health

In this paper, Dobbie, Goldsmith-Pinkham, and Yang estimate the effect of Chapter 13 bankruptcy protection on post-filing financial outcomes using a new dataset linking bankruptcy filings to credit bureau records. Their empirical strategy uses the leniency of randomly-assigned judges as an instrument for Chapter 13 protection. Over the first five post-filing years, the researchers find that Chapter 13 protection decreases an index measuring adverse financial events such as civil judgments and repossessions by 0.316 standard deviations, increases the probability of being a homeowner by 13.2 percentage points, and increases credit scores by 14.9 points. Chapter 13 protection has little impact on open unsecured debt, but decreases the amount of debt in collections by $1,315. The authors find evidence that both debt forgiveness and protection from debt collectors are important drivers of their results.

Andrew Daughety and Jennifer F. Reinganum, Vanderbilt University

Informal Sanctions on Prosecutors and Defendants and the Disposition of Criminal Cases

Daughety and Reinganum model the strategic interaction between a prosecutor and a defendant when informal sanctions by outside observers may be imposed on both the defendant and the prosecutor. Non-strategic outside observers rationally use the disposition of the case (plea bargain, case drop, acquittal, or conviction) to impose these sanctions, but also recognize that errors in the legal process (as well as hidden information) means they may misclassify defendants and thereby erroneously impose sanctions on both defendants and prosecutors. If third parties prefer a legal system with minimal expected loss from misclassification, there is a unique prediction wherein the guilty defendant accepts the prosecutor's proposed plea offer with positive (but fractional) probability, the innocent defendant rejects the proposed offer, and the prosecutor chooses to take all defendants who reject the offer to trial. Furthermore, the researchers show that: 1) changes in the level of the formal sanction affect the level of informal sanctions imposed by outsiders on defendants and prosecutors; and 2) increases in the informal sanction rate imposed on prosecutors results in changes in the level of informal sanctions imposed on defendants. The latter case is particularly noteworthy, as (for example) an increase in the rate associated with informally sanctioning prosecutors for convicting the innocent can result in an increase in the level of informal sanctions by third parties on innocent defendants. The researchers use the base model to examine two extensions of the analysis. In the first extension, they assume that a fraction of defendants are risk and/or ambiguity averse. If this response is strong enough, then some innocent defendants accept the prosecutor's plea offer. In the second extension, they consider the effect of increasing the informativeness of the jury's decision by extending the model to allow for a three-verdict outcome (not guilty, not proven, and guilty), sometimes referred to as the "Scottish" verdict. The authors find that: 1) guilty defendants are worse off, as plea bargains get tougher but the rejection rate does not change; 2) innocent defendants are better off; 3) the prosecutor's overall payoff goes up; and 4) the outside observers' concern over possible misapplication of informal sanctions is reduced. In this sense, the Scottish verdict is justice-improving when compared with the standard (two-outcome) verdict.

Adair Morse, University of California, Berkeley and NBER, and Wei Wang and Serena Wu, Queens University

Executive Gatekeepers: Useful and Divertible Governance

Morse, Wang, and Wu study the paradox of executive lawyers serving multiple tasks, being both gatekeepers and executives. The researchers document that general counsels impact outcomes associated with both tasks; general counsel fixed effect explains 4.6% of variation in governance across firms and 2.8% in investment. The authors then consider whether compensation incentives drive the effort choice among tasks. Using an identification strategy based on the sociology literature of what it means to be a professional with dual loyalties, they find that a one standard deviation increase in executive lawyers' compensation delta diverts at least two-thirds of the prevention of securities fraud associated with hiring an executive gatekeeper. Their evidence suggests that these executive lawyers instead spend time on mitigating innovation legal risk, thereby facilitating R&D. Gatekeepers do not get diverted, however, in regulatory compliance. The researchers provide evidence refuting an (interesting) alternative interpretation that lawyer gatekeepers are hired as strategy officers and are only totems of governance.

Jialin Wang, Consumer Financial Protection Bureau, and Benjamin J. Keys, University of Chicago

Minimum Payments and Debt Paydown in Consumer Credit Cards

What factors impact how much consumers repay on their credit cards each month? This paper examines the drivers of payment behavior using the CFPB credit card database, which includes the monthly account activity of a large fraction of U.S. consumers from 2008-2012. Keys and Wang find that consumers' payment behavior is consistent and strongly bimodal. Most accounts are either paid in full or paid near the minimum amount each month, with very few intermediate payment amounts. The researchers then evaluate the impact of two types of policy changes: 1) changes in the minimum payment formulas implemented by individual issuers, and 2) new payment disclosures mandated by the CARD Act of 2010. The formula changes led to small increases in the payments made by consumers previously paying the minimum. On average, the CARD Act disclosures increased consumer payments by $19 per month from February 2010 to December 2012. However, both the formula changes and the CARD Act's three-year payment disclosure had the effect of decreasing the fraction of accounts paid in full by 1%. The authors' results suggest that anchoring and the salience of minimum payments play important roles in consumer decision-making in the credit card market.

Jose Liberti and Jason Sturgess, DePaul University; Charles W. Calomiris, Columbia University and NBER; and Mauricio Larrain, Columbia University

How Collateral Laws Shape Lending and Sectoral Activity