Law and Economics

February 6, 2009
Christine Jolls, Organizer

Rosalind Dixon, University of Chicago Law School, and Richard Holden, MIT and NBER, Amending the Constitution: Article V and the Effect of Voting Rule Inflation

Dixon and Holden show that even if the original Article V amendment requirement were deemed optimal, the effective supermajority that it requires has increased substantially over time as the size of the relevant voting bodies has increased. Calibrating a general model of supermajority voting rules based on the optimality of the original requirements, they show that the requirement in Article V -- that an amendment be supported by 2/3 of each House of Congress and 3/4 of State Legislatures -- now would be equivalent to a requirement of support by 53 percent of the House, 59 percent of the Senate, and 62 percent of State Legislatures. Without this “voting rule inflation” effect, the authors find that several proposed Amendments to the Constitution likely would have passed. Voting rule inflation thus is shown to be an important consideration for any constitutional designer.

Vikrant Vig, London Business School, Access to Collateral and Corporate Debt Structure:  Evidence from a Natural Experiment

Vig examines the effect of a secured transactions reform passed in India that strengthened the rights of secured creditors on the equilibrium use of secured debt by corporations. The law allowed secured creditors faster access to the pledged collateral in the event of default and thus was expected to reduce the deadweight cost of seizing collateral. Such a reform should improve welfare, because it lowers the cost of borrowing and expands the space of available debt contracts for borrowers. A lower cost of borrowing should translate into greater use of secured debt. Contrary to this view, though, Vig finds that the passage of the secured transactions law led to a movement away from secured debt. Specifically, he finds that passage of this act led to a decrease in the use of secured debt by corporations. This suggests that strengthening creditor rights may lead to adverse effects for some firms and may not necessarily improve welfare in the Pareto sense.

Alberto Galasso, University of Toronto, and Mark Schankerman, London School of Economics, Patent Thickets and the Market for Innovation:Evidence from Settlement of Patent Disputes

Galasso and Schankerman study how fragmentation of patent rights (“patent thickets”) and the formation of the Court of Appeal for the Federal Circuit (CAFC) affected the duration of patent disputes, and thus the speed of technology diffusion through licensing. They develop a model of patent litigation that predicts faster settlement agreements when patent rights are fragmented and when there is less uncertainty about court outcomes, as was associated with the “pro-patent shift” of CAFC. Their model also predicts that the impact of fragmentation on settlement duration should be smaller under CAFC. The authors confirm these predictions empirically using a dataset that covers nearly all patent suits in U.S. federal district courts during the period 1975-2000. Finally, they analyze how fragmentation affects total settlement delay, taking into account both reduction in duration per dispute and the increase in the number of required patent negotiations associated with patent thickets.

Haresh Sapra, University of Chicago; Ajay Subramanian, Georgia State University; and Krishnamurthy Subramanian, Emory University, Corporate Governance and Innovation: Theory and Evidence

Sapra, Subramanian, and Subramanian develop a theory of the effects of external corporate governance mechanisms, such as takeover pressure, and internal mechanisms, such as compensation contracts and monitoring intensity, on innovation. Their theory generates the following testable predictions: 1) innovation varies non-monotonically in a U-shaped manner with takeover pressure; 2) innovation increases with monitoring intensity; and 3) the sensitivity of innovation to changes in takeover pressure declines with monitoring intensity. They show strong empirical support for these predictions using both ex ante and ex post measures of innovation. Their empirical analysis exploits the cross-sectional as well as time-series variations in takeover pressure created by the sequential passage of anti-takeover laws across different states. Their study suggests that innovation is fostered by either an unhindered market for corporate control or strong anti-takeover laws that significantly deter takeovers. An unhindered market for corporate control fosters innovation through the incentives provided by takeover premiums that increase with the degree of innovation. Severe anti-takeover laws may, however, also encourage innovation ex ante by reducing the likelihood of ex post private control benefit losses. The interplay between the relative magnitudes of these conflicting forces causes innovation to vary non-monotonically with takeover pressure.

Edward L. Glaeser, Harvard University and NBER, and Gergely Ujhelyi, University of Houston, Regulating Misinformation (NBER Working Paper No. 12784)

The government has responded to misleading advertising by banning it, engaging in counter-advertising, and taxing the product. Glaeser and Ujhelyi consider the social welfare effects of those different responses to misinformation. While misinformation lowers consumer surplus, its effect on social welfare is ambiguous. Misleading advertising leads to overconsumption, but that may be offsetting the under-consumption associated with monopoly prices. If all advertising is misinformation, then a tax or quantity restriction on advertising maximizes social welfare. Other policy interventions are inferior and cannot improve on a pure advertising tax. If it is impossible to tax misleading information without also taxing utility increasing advertising, then combining taxes or bans on advertising with other policies can increase welfare.

Marco Ottaviani and Abraham L. Wickelgren, Northwestern University, Policy Timing under Uncertainty

Ottaviani and Wickelgren analyze the optimal combination of ex ante and ex post regulation of an activity that generates an uncertain externality, with an extensive application to merger control. While additional information about the social desirability of a merger becomes available only after the merger takes place, it then becomes more costly to “unscramble the eggs.” The authors characterize when it is optimal to forego the option to reevaluate the merger ex post. The case for ex post review is strengthened if the firm is able to signal its private information about the consequences of the merger through market conduct.

Ernesto Dal Bo and Marko Tervio, University of California, Berkeley and NBER, Self-Esteem, Moral Capital, and Wrongdoing” (NBER Working Paper No. 14508)

Dal Bo and Tervio present an infinite-horizon model of moral standards where self-esteem and unconscious drives play key roles. In the model, an individual receives random temptations (such as bribe offers) and must decide which to resist. Individual actions depend both on conscious intent and a type reflecting unconscious drives. Temptations yield consumption value, but keeping a good self-image (a high belief of being the type of person that resists) yields self-esteem. The authors identify conditions for individuals to build an introspective reputation for goodness ("moral capital") and for good actions to lead to a stronger disposition to do good. Bad actions destroy moral capital and lock-in further wrongdoing. Economic shocks that result in higher temptations have persistent effects on wrongdoing that fade only as new generations replace the shocked cohorts. Small parametric differences across societies may lead to large wrongdoing differentials, and societies with the same moral fundamentals may display different wrongdoing rates depending on how much past luck has polarized the distribution of individual beliefs. The model illustrates how optimal deterrence may change under endogenous moral costs and how wrongdoing may be compounded as high temptation activities attract individuals with low moral capital.

Daniel L. Chen and Jasmin Sethi, Harvard University, The Effects of Sexual Harassment Law on Gender Inequality

Chen and Sethi identify the impact of court-made sexual harassment law on gender inequality by using the fact that federal judges are randomly assigned to appellate cases along with the fact that female judges and Democratic appointees decide sexual harassment cases differently than do male judges and Republican appointees. The authors find that sexual harassment law does not appear to exacerbate gender inequality. It increases female wages and employment relative to those of men and increases the proportion of female managers relative to male managers. However, when restricted to people previously in the work force, sexual harassment law worsens female employment outcomes. These findings are more consistent with an insider-outsider theory of involuntary unemployment, where insiders harass outsiders in order to capture economic rents and forbidding harassment raises both employment and wages of outsiders, than with compensating wage differential models of sexual harassment. One of the more surprising results is that the positive effect on female management comes entirely from sexual harassment law, not gender discrimination law, highlighting a practical contribution of feminist interpretation. Moreover, while damages awarded in sexual harassment cases have a positive effect on gender inequality, law trumps economics, particularly legal doctrine, in a horse race between different measures of sexual harassment law, providing novel evidence that people may obey the law because of its legitimacy rather than its incentive effects.

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