Law and Economics

February 7, 2014
Christine Jolls of Yale Law School, Organizer

Alain Cohn and Michel Marechal, University of Zurich, and Thomas Noll, Swiss Prison Staff Training Center

Bad Boys: How Criminal Identity Affects Rule Violation

Cohn, Marechal, and Noll conduct an experiment with 182 inmates from a maximum security prison to analyze the impact of criminal identity on cheating. The results demonstrate that inmates cheat more when their criminal identity is rendered more salient. This effect is specific to individuals possessing a criminal identity because an additional placebo experiment shows that regular citizens do not become more dishonest in response to crime-related reminders. Moreover, the authors' experimental measure of cheating correlates with inmates' offenses against in-prison regulation. Altogether, these findings suggest that criminal identity plays a crucial role in rule-violating behavior.

Jared Stanfield, UNSW, and Robert Tumarkin, University of New South Wales

The Effect of the Political Power of Unions on Firm Value

Prior research has established a relationship between union bargaining power and firm value and financial decisions. However, researchers have not fully explored how unions establish this power. In this study, Stanfield and Tumarkin find that a union's bargaining power depends significantly on the union's political power. The authors explore this connection by making use of a recent law in New South Wales, Australia that prohibits unions from making political contributions and restricts their political activities, but leaves their ability to collectively bargain unchanged. They find that the value of unionized firms in New South Wales significantly increased in the wake of this legislation and that these firms were able to negotiate more favorable labor contracts relative to their unionized peers in other states. The authors propose that unionized labor uses political power to increase its ability to extract rents from shareholders.

Decio Coviello, HEC Montreal, and Nicola Persico, Northwestern University and NBER

An Economic Analysis of Black-White Disparities in NYPD's Stop and Frisk Program (NBER Working Paper 18803)

Coviello and Persico study the possible racial bias of the police involved in the New York Police Department's (NYPD) "stop and frisk" program. A model is introduced to explore the identification of two distinct sources of bias: bias at the level of the police officer making the stop decisions, and bias at the level of the police chief allocating manpower across precincts. Previous research offered positive identification results regarding officer bias; this paper adds a new, and negative, identification result for police chief bias. Ten years of data from the NYPD's "stop and frisk" program are analyzed in light of this theoretical framework. White pedestrians are found to be slightly less likely than African American pedestrians to be arrested conditional on being stopped. The authors interpret this as evidence that the officers making the stops are not biased on average against African Americans relative to whites because the latter are being stopped despite being a "less productive stop" for a police officer. When the same likelihood is computed at the precinct level, the authors find heterogeneity in measured bias among precincts. They correlate, without arguing causality, this measure of bias with a number of precinct characteristics. Separately, the authors find no cross-precinct correlation between this measure and the relative intensity of police pressure on African American residents (relative to pressure on whites). This absence of correlation seems to go against the presumption that large disparities in police pressure are necessarily the result (or even the correlate) of police officer bias.

Mariassunta Giannetti, Stockholm School of Economics, and Tracy Yue Wang, University of Minnesota

Corporate Scandals and Household Stock Market Participation

Giannetti and Wang show that after the revelation of corporate fraud in a state, the equity holdings of households in that state decrease significantly both in the extensive and the intensive margins. Using an exogenous shock to fraud detection and exogenous variation in households' lifetime experiences of corporate fraud, the authors establish that the impact of fraud revelation in local companies on household stock market participation is causal. Even households that did not hold stocks in the fraudulent firms decrease their equity holdings, and all households decrease their holdings in fraudulent firms as well as in non-fraudulent firms. As a consequence of the decrease in local households' demand for equity, firms headquartered in the same state as the fraudulent firms experience a decrease in valuation and in the number of shareholders.

Rohan Pitchford, Australian National University, and Christopher Snyder, Dartmouth College and NBER

Mortgage Origination and the Rise of Securitization: An Incomplete-Contracts Model

Recent empirical studies find that securitized mortgages yield higher default rates than those which are originated and held by the same party, raising a number of theoretical puzzles which Pitchford and Snyder address with a model based on incomplete contracts. Their model combines the features of diversion (along the lines of Hart and Moore 1989, 1998), with asymmetric information regarding borrowers' default risk (as in Stiglitz and Weiss 1981) and soft information screening by lenders. The authors show that securitization weakens the incentive to screen compared with bank-originated-and-held loans, and that securitization is more prevalent (inter alia) with rising house prices, lower interest rates, reduced liquidation costs, and higher bank regulation costs. Extending the basic model to the case of stochastic prices allows the authors to analyze strategic default: enforcement of recourse loans or policies to encourage renegotiation reduces repayments and default rates in the model. In a final extension, the authors assume a rise in the volume of mortgage-default properties raises the depreciation rate of such properties in the second-hand market. This systemic factor introduces multiple equilibria, that is, either securitized or bank-held mortgages (not both at the same time) exist within a region. Securitized mortgages can generate significantly lower welfare if depreciation is sufficiently high so that mortgage markets in this region are fragile if external factors can shift the equilibrium from banking (with its low default rate) to securitization (with its higher rate).

Edward Morrison, University of Chicago; Arpit Gupta, Columbia Business School; and Lenora Olson, Lawrence Cook and Heather Keenan, University of Utah

Health And Financial Fragility: Evidence From Car Crashes And Consumer Bankruptcy

Morrison, Gupta, Olson, Cook, and Keenan assess the importance of adverse health shocks as triggers of bankruptcy filings. The authors view car crashes as a proxy for health shocks and draw on a large sample of police crash reports linked to hospital admission records and bankruptcy case files. They report two findings: 1, there is a strong positive correlation between an individual's pre-shock financial condition and his or her likelihood of suffering a health shock, an example of behavioral consistency; and 2, after accounting for this simultaneity the authors are unable to identify a causal effect of health shocks on bankruptcy filing rates. These findings emphasize the importance of risk heterogeneity in determining financial fragility, raise questions about prior studies of "medical bankruptcy," and point to important challenges in identifying the triggers of consumer bankruptcy.

Sumit Agarwal, National University of Singapore; Souphala Chomsisengphet, Department of the Treasury; Neale Mahoney, University of Chicago and NBER; and Johannes Stroebel, New York University

Regulating Consumer Financial Products: Evidence from Credit Cards (NBER Working Paper 19484)

Agarwal, Chomsisengphet, Mahoney, and Stroebel analyze the effectiveness of consumer financial regulation by considering the 2009 Credit Card Accountability Responsibility and Disclosure (CARD) Act in the United States. Using a quasi-experimental research design and a unique panel dataset covering more than 150 million credit card accounts, they find that regulatory limits on credit card fees reduced overall borrowing costs to consumers by an annualized 1.7 percent of average daily balances, with a decline of more than 5.5 percent for consumers with the lowest FICO scores. Consistent with a model of low fee salience and limited market competition, the authors find no evidence of an offsetting increase in interest charges or a reduction in volume of credit. Taken together, the authors estimate that the CARD Act fee reductions have saved U.S. consumers $12.6 billion per year. They also analyze the CARD Act requirement to disclose the interest savings from paying off balances in 36 months rather than only making minimum payments. They find that this "nudge" increased the number of account holders making the 36-month payment by 0.5 percentage points.

Vyacheslav Fos , University of Illinois at Urbana-Champaign, and Wei Jiang, Columbia University

Out-Of-The-Money CEOs: Private Control Premium and Option Exercise by CEOs

Fos and Jiang infer CEOs' (and insiders') private benefits of control from their option exercise behavior. They document two salient patterns: First, the presence of a proxy contest triples the probability that an insider exercises call options out of the money, a strategy deemed unambiguously irrational under the conventional models without a control premium. Second, CEOs are significantly less (slightly more) likely to exercise options in order to sell (hold) the resulting shares when a proxy contest is looming. Both cases are consistent with the hypothesis that CEOs' valuation of their stocks exceeds that of the market price by the amount of their private control premium. When such benefits of control are at risk, combined with restrictions on trading in stocks by insiders, CEOs distort their option exercises in order to boost their actual or potential voting power. A conservative lower-bound estimate of the median private control premium amounts to 13 percent of the stock value. The authors further show that the control motive in option exercise is distinct from other motives documented in the literature, including diversification, inside information about future stock prices, and behavioral factors such as overconfidence.

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