Spring 2016 Workshop
Ariel Porat (Tel-Aviv University) and Robert E. Scott (Columbia University)
Using Restitution to Support Business Networks
This article examines the dramatic increase in business networks in recent decades and considers whether the law can play a useful role in supporting the efficient functioning of these inter-firm relationships for coordination and cooperation. Repeat play, reputational sanctions, and norms of trust and reciprocity are the common explanations for the flourishing of networks in many industries and places. But the evidence also shows that many emerging networks fail to form or function effectively. Lacking a controlling entity, they are “webs without any spider.” Clusters of industrial districts are traditional examples of this class of network. More recently, the information revolution has stimulated a dramatic increase in networks of strategic alliances that are now a common means of organizing collaborations among firms in high technology and R & D intensive settings. In both these types of “spiderless” networks there are no legal mechanisms to control moral hazard and free riding risks during the period of network formation and operation. We ask under what conditions would legal mechanisms effectively complement existing relational modes of motivating reciprocity among network members? We first develop an informal model that uses the law of restitution and unjust enrichment to encourage efficient network formation and operation by allowing key participants to receive some of the benefits currently captured by other participants. We then relax the restrictive assumptions of the model to consider the many problems of implementation, including difficulties in verifying costs and benefits, litigation error costs and the risk that a legal remedy may crowd out rather than braid with the relational forces that otherwise support network formation. This analysis argues in favor of low-powered legal remedies such as the recovery of a portion of the realized benefits from network participation. Even though there are substantial hurdles to overcome in implementing a restitution remedy for fragile alliances, we argue that a narrowly structured right of restitution can function as a background rule for sharing the benefits and costs among alliance network members, motivating these parties to overcome the coordination problems that otherwise deter them from creating a spider to organize the distribution of network value. We apply our analysis to a few well known existing networks, including the Silicon Valley network and the Apple-Sony-IBM network.
Mitu Gulati (Duke University) and Robert E. Scott (Columbia University)
The Costs of Encrusted Contract Terms
The fact that repetitive or rote use of a standard form contract term can erode its meaning, especially when encrusted by legal jargon, is not a new observation. This process weakens the communicative properties of boilerplate terms, reducing their reliability as signals of what the parties really mean. What is less certain is what interpretive strategy courts should use to give meaning to encrusted boilerplate that is the focus of litigation. Standard doctrine holds that a textual analysis of the language should suffice, particularly in worlds populated by sophisticated parties, even if the meaning is not clear. After all, if the sophisticated parties disagree with the court’s interpretation, they have strong incentives to revise the standard language to exclude the aberrant interpretation. And surely, the assumption goes, they can easily do so. But what if the foregoing assumptions about the costs of revising boilerplate are wrong? What if there are circumstances where sophisticated commercial parties systematically fail to react promptly to judicial errors in interpreting boilerplate terms, or are unable thereafter easily to convert the encrusted boilerplate into a new and intelligible formulation. In this paper we seek to gain some purchase on these questions by reporting the results of an extensive case study of the pari passu clause, a standard boilerplate formulation common to sovereign debt contracts for over 150 years. The first disputed interpretation of the clause occurred in 2000, was affirmed by a different court in 2011, and affirmed again on appeal in that same case in 2012 and 2013, despite the fact that the aberrant interpretation was almost universally condemned by market participants. Yet, meaningful change in the language of the boilerplate term did not begin to appear until late 2014. And, as of January 2016, while one segment of the sovereign market has repudiated the 2000 interpretation wholesale, change in the other segments has still not occurred. This data, together with interviews with market participants, points to agency costs as the friction that may explain why daunting collective action problems impaired the efforts of public institutions to assist the market in clarifying the meaning of the boilerplate term. And, in turn, that suggests that courts should not necessarily assume that errors in interpreting encrusted boilerplate will be easily corrected by the market.
Jared Ellias (UC-Hastings College of the Law)
What Drives Bankruptcy Forum Shopping? Evidence from Market Data
Bankruptcy lawyers have used the versatility of the bankruptcy code’s venue provisions to transform the Federal Bankruptcy Courts of the Southern District of New York and Delaware into pseudo-national bankruptcy courts that have presided over the majority of corporate reorganizations in the past twenty-five years. Some commentators believe that firms prefer those two courts because their expertise and experience make bankruptcy more predictable. Critics cast doubt on this explanation, arguing instead that “predictability” is a cloak that hides the true, self-interested motivation of the managers, lawyers and secured lenders that influence the bankruptcy venue decision. In this paper, I look for evidence supporting the views of the proponents and detractors of bankruptcy forum shopping in a new hand-collected sample of traded claims of bankrupt firms over a recent sample period in which the two destination courts had become dominant. I find that the market appears to be better at predicting the outcomes of bankruptcy cases in the two destination venues, suggesting that New York and Delaware’s expert judges and store of precedent might improve the predictability of the bankruptcy process. This pricing advantage appears to persist through the early part of the bankruptcy process but disappears in the data as the firm moves closer to emergence from bankruptcy. I also find evidence that judicial expertise and precedent limits the value of hold-up litigation and assists creditors’ lawyers in calibrating legal strategies in Delaware, the most experienced venue. Finally, I do not find evidence suggesting that the destination courts are biased in favor of senior creditors or managers.
Martin Hellwig (Max Planck Institute for Research on Collective Goods)
Financial Stability and Monetary Policy in a Time of Crisis
The talk discusses the role of financial stability in monetary policy in the financial crisis of 2007-2009 and the European crisis since 2010. Major concerns are (i) the microeconomic/financial underpinnings of the monetary system and the role of the central bank as a lender of the last resort, (ii) the role of financial stability as an objective for monetary policy, (iii) financial dominance and hidden fiscal dominance as threats to the independence of monetary policy. The conceptual issues are illustrated by an account of the European experiences and discussions, including the move to banking union and the legal discussion about the European Central Bank’s purchases of government bonds.
Albert Choi (University of Virginia)
Taking a Financial Position in Your Opponent in Litigation
We explore a model of litigation where the party bringing the lawsuit, the plaintiff, can acquire a financial position in the target firm, the defendant. The plaintiff gains a strategic advantage by taking a short financial position in the defendant’s stock. First, the plaintiff can turn what would otherwise be a negative expected value claim (including a frivolous one) into a positive expected value one. Second, the short financial position raises the minimum amount the plaintiff is willing to accept in settlement, thereby increasing the settlement amount. Conversely, taking a long position in the defendant’s stock puts the plaintiff at a strategic disadvantage. When the capital market is initially unaware of the lawsuit, the plaintiff can profit both directly and indirectly from its financial position. When the defendant is privately informed of the merit of the case, the plaintiff balances the strategic benefits of short position against the costs of bargaining failure and trial. Short selling by the plaintiff can, under certain circumstances, benefit both the plaintiff and the defendant and also reduce the rate of litigation.
Alexander Stremitzer and Rebecca Stone (UCLA)
Promises, Reliance, and Psychological Lock-In
In the absence of a legal regime enforcing promises, the classical prediction of contract theory is that promisees will underinvest in reliance whenever the promisor is likely to have a self-interested reason to break her promise. But if a promisor experiences guilt when she breaks her promise, this guilt may be intensi
fied by the promisee's reliance on the promise. Anticipating this, the promisee has a strategic reason to overinvest in reliance in order to psychologically lock the promisor into keeping her promise. A legal regime that enforces promises may therefore have the unexpected benefi
t of reducing overreliance as promisees no longer have to rely on the extra-legal mechanism of psychological lock-in in order to induce a promisor to keep her promise. We obtain experimental evidence supporting the existence of this psychological lock-in effect.
Alan Schwartz (Yale) and Ronald J. Gilson (Columbia)
Defensive Tactics and Optimal Search: A Simulation Approach
The appropriate division of authority between a company’s board and its shareholders has been the central issue in the corporate governance debate for decades. This issue presents most vividly for defensive tactics: the extent to which the board of a potential acquisition target is allowed to prevent the shareholders from responding directly to a hostile bid. In the US today, the board’s power is extensive; control largely lies with the board. Normative evaluations of current law face two obstacles. First, defensive tactics raise the social welfare question whether, or to what extent, these tactics deter ex ante efficient takeovers. This question cannot be answered empirically because the econometrician can observe bids but cannot observe deterred bids. The social welfare issue is also difficult to resolve using current analytical techniques because the market for corporate control is unusually complex: in it, financial and strategic buyers search for mismanaged companies or synergy targets; and some synergy targets search for acquirers. Turning to targets, the question which defensive tactics level maximizes shareholder welfare also is difficult to answer because of the qualitative nature of defensive tactics: Is a poison pill more or less privately efficient than a staggered board? What are the welfare consequences of combining a pill with a staggered board or a supermajority voting requirement? In this paper, we write a search equilibrium model of the market for corporate control and solve it by simulating plausible parameters for the variables of interest. Because we specify the number of ex ante efficient acquisitions that could be made, we can estimate market efficiency – the ratio of made matches to good matches – under legal regimes that are more or less friendly to defensive tactics. Also, we argue that the common metric among defensive tactics is time: the ability of various tactics to delay bid completion and thus reduce bidder, and thereby increase target, returns.
We have two important results: First, strong defensive tactics reduce market efficiency significantly. Our simulations suggest that the value of lost acquisitions is over $250 billion a year. Simulations are only suggestive and our simulated model likely overstates the welfare loss. Nevertheless, the result that defensive tactics cause economically significant welfare losses would stand even if our magnitude estimate is halved. Second, the defensive tactics level that maximizes target shareholder welfare is materially higher than the level that maximizes social welfare. These results also support a methodological claim: equilibrium analysis can illuminate regulatory issues regarding the market for corporate control.
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Please note that the linked papers may not be the most current version, as these were the papers used during the workshop.