Law and Economics

Members of the NBER's Law and Economics Program met February 15 in Cambridge. Program Director Christine Jolls of Yale University organized the meeting. These researchers' papers were presented and discussed:

Andrew Daughety and Jennifer Reinganum, Vanderbilt University

Reducing Unjust Convictions: Plea Bargaining, Trial, and Evidence Suppression/Disclosure

Daughety and Reinganum develop a dynamic model of the disposition of a criminal case, allowing for the potential discovery of exculpatory evidence by prosecutors (who choose whether to disclose this evidence) and by defendants, as the case proceeds from arrest through plea bargaining and (possibly) trial. The researchers characterize equilibrium behavior by prosecutors and defendants, under three different disclosure regimes: (1) no disclosure is required, (2) disclosure is required before trial, and (3) disclosure is required from the point of arrest onward. A prosecutor who has (resp., has not) privately observed exculpatory evidence is called an "informed" (resp., "uninformed") prosecutor. When no disclosure is required, an informed prosecutor makes a lower plea offer than one who is uninformed, no case is dropped voluntarily. When disclosure is required only prior to trial, then an informed prosecutor makes the same offer as an uninformed prosecutor, but an informed prosecutor will disclose and drop the case following a rejected plea offer. Finally, when the prosecutor is required to disclose prior to plea bargaining, then an informed prosecutor discloses and drops the case, whereas an uninformed prosecutor makes the same offer as in the no-disclosure regime, and never voluntarily drops the case. In all regimes, some innocent defendants accept the plea offer and others reject it (and similarly for guilty defendants). The study finds that both regimes requiring some disclosure, as compared with a no-disclosure regime, are (at least weakly) more likely to convict the guilty and less likely to convict the innocent (regardless of whether the prosecutor is informed or uninformed). However, the more-limited disclosure regime, as compared to the more-extensive regime, leads to a higher likelihood of conviction for innocent defendants facing an informed prosecutor, but a lower likelihood of conviction of innocent defendants facing an uninformed prosecutor and a lower likelihood of conviction of guilty defendants.

Albert Choi, University of Virginia, and Kathryn E. Spier, Harvard University and NBER

Class Actions and Private Antitrust Litigation

Choi and Spier analyze the effect of class actions and class action waivers on firms' ability to collude and fix market prices. The researchers model class action as a mechanism that allows plaintiffs to lower their litigation costs. The research shows that when the cost of individual litigation is sufficiently low, firms endure lawsuits in equilibrium and swallow the litigation costs as just another cost of doing business. In this case, firms have an incentive to allow class actions and this is also socially optimal. By contrast, when the cost of individual litigation is above a threshold, the firms set the market price so that future litigation is deterred. In this case, firms may want to impose class action waivers (and disallow class actions). By doing so, they can raise the market price and increase their profits, but this is socially sub-optimal. Various extensions, such as possible settlement, asymmetric information, contingent fee payments, fee shifting, and damages multiplier, are also examined.

Martijn Cremers, University of Notre Dame; Scott Guernsey, University of Cambridge; and Simone M. Sepe, University of Arizona

Directors' Duties Laws and Long-Term Firm Value

Cremers, Guernsey, and Sepe analyze the long-term value impact of enhanced director discretion to consider the interests of all stakeholders by exploiting the quasi-natural experiment provided by the staggered adoption of directors' duties laws (also known as corporate constituency statutes) in 35 U.S. states over the period 1984 to 2006. The researchers document that the enactment of these laws results in an economically and statistically significant increase in firm value. The increase in firm value is stronger for larger and more complex firms, firms more exposed to endogenous uncertainty and with stronger stakeholder relationships. The results support the bonding hypothesis that enhanced director discretion to protect stakeholder interests promotes long-term firm value by reducing a firm's contracting costs. They also support the view that enhanced director discretion help internalize the externalities that firms create in incomplete markets, leading to more efficient production to the benefit of all stakeholders, including shareholders.

Huseyin Gulen, Purdue University, and Brett W. Myers, Texas Tech University

The Selective Enforcement of Government Regulation: Battleground States and the EPA

The Electoral College creates incentives for politicians and regulators to direct policy favors to "battleground" states, which represent the median voter in presidential elections. Gulen and Myers determine whether regulators treat battleground states favorably by examining whether the EPA is less likely to find a regulated facility in violation of the Clean Water Act if it is in a battleground state. The researchers find that violation rates for these facilities are significantly lower than those in non-battleground states. Identification is obtained by the analysis of the violation rates of similar facilities located along the border between battleground and non-battleground states.

Alexander Dyck, University of Toronto; Adair Morse, University of California, Berkeley and NBER; and Paulo Marti. Manoel, University of California, Berkeley

Outraged by Compensation: Implications for Public Pension Performance

Dyck, Morse, and Manoel model public pension funds that contract with investment managers and the resulting portfolio allocation and performance. Frictions in optimal contracting emerge from board members' sensitivity to employee and public outrage over high compensation. In global data covering $5.4 trillion in assets, the researchers estimate a system of compensation and returns equations. Relaxing outrage constraints by one standard deviation results in $81,000-$179,000 more compensation, and $13-32 million of incremental value-add annually for an average public pension fund (15-35 bps excess performance in alternatives and 8-18 bps in public equities). Outrage is orthogonal to distortions from underfunding and political payoffs to local investment.

Lucian A. Bebchuk, Harvard University and NBER, and Doron Y. Levit, University of Pennsylvania

Myopic Shareholders

Public officials, business leaders, and academics have expressed concerned that allowing investors with short-term investment horizon to initiate and vote on changes in the governance of public companies can be expected to exacerbate short-termism, and have made influuential proposals to eliminate or constrain the shareholder rights of such short-term investors. Bebchuk and Levit develop a model to study whether such proposals could be expected to enhance the long-term value of public companies. To this end, the researchers extend the canonical Stein Model (Stein 1988 and Stein 1989) by allowing for governance structures, pay schemes, and director selection to be determined endogenously and influenced by shareholder preferences. Using this standard framework for analyzing short-termism, the researchers find that governance structures that give rise to some level of corporate myopia can provide benefits to long-term investors that could lead to their adoption even when short-term investors are denied participation rights. Most importantly, the research shows that short-term investors have the same preferences with respect to governance structures, pay schemes, and director selections as long-term shareholders and, contrary to widely expressed concerns, short-term investors would not prefer choices making long-term shareholders worse-off. The researchers' analysis indicates that the standard economic framework for studying short-termism does not provide a basis for eliminating or weakening the rights of short-term shareholders to participate in the governance of public companies.

Marcella Alsan, Stanford University and NBER, and Crystal Yang, Harvard University and NBER

Fear and the Safety Net: Evidence from Secure Communities (NBER Working Paper No. 24731)

Alsan and Yang explore the impact of fear on the incomplete take-up of safety net programs in the United States. They exploit changes in deportation fear due to the roll-out and intensity of Secure Communities (SC), an immigration enforcement program that empowers the federal government to check the immigration status of anyone arrested by local police, leading to the forcible removal of approximately 380,000 immigrants. The researchers estimate the spillover effect of SC on the take-up of federal means-tested programs by Hispanic citizens. Though not at personal risk of deportation, Hispanic citizens may fear their participation could expose non-citizens in their network to immigration authorities. The researchers find significant declines in SNAP and ACA enrollment, particularly among mixed-citizenship status households and in areas where deportation fear is highest. The response is muted for Hispanic households residing in sanctuary cities. The results are most consistent with network effects that perpetuate fear rather than lack of benefit information or stigma.

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