Working Papers 301-310
301. Independent Directors and Stock Market Prices: The New Corporate Governance Paradigm (Gordon, Jeffrey N.)
Over the 1950-2005 period, the composition of large public company boards dramatically shifted towards independent directors, from 20 percent independents to 75 percent independents. The standards for independence also became increasingly rigorous over the period. The available empirical evidence provides no convincing explanation for this change. This paper explains the trend in terms of two interrelated developments in US political economy. First is the shift to shareholder value as the primary corporate objective; the second is the greater informativeness of stock market prices. The overriding effect is to commit the firm to a shareholder wealth maximizing strategy as best measured by stock price performance. In this environment, independent directors are more valuable than insiders. They are less committed to management and its vision. Instead, they look to outside performance signals and are less captured by the internal perspective, which, as stock prices become more informative, becomes less valuable. They can be more readily mobilized by legal standards to help provide the public goods of more accurate disclosure (which improves stock price informativeness) and better compliance with law. They are an essential part of a new corporate governance paradigm. Although independent directors will not invariably play this role, in the United States independent directors have become a complementary institution to an economy of firms directed to maximize shareholder value. Thus the rise of independent directors and the associated corporate governance paradigm should be evaluated in terms of this overall conception of how to maximize social welfare.
Keywords: Corporate Governance, Independent Directors, Shareholder Value
302. Deconstructing Equity: Public Ownership, Agency Costs, and Complete Capital Markets, (Gilson, Ronald J. and Charles K. Whitehead)
Forthcoming in Columbia Law Review; ECGI - Law Working Paper No. 86 ; Stanford Law and Economics Olin Working Paper No. 346; Boston University School of Law Working Paper No. 07-25
The traditional law and finance focus on agency costs presumes, without acknowledgement, that the premise that diversified public shareholders are the cheapest risk-bearers is immutable. In this Essay, we raise the possibility that changes in the capital markets have called this premise into question, drawn into sharp relief by the recent private equity buying wave in which the size and range of public companies being taken private expanded significantly. In brief, we argue that private owners, in increasingly complete markets, can transfer risk in discrete slices to counterparties who, in turn, can manage or otherwise diversify away those risks they choose to forego, arguably becoming a lower cost substitute for traditional risk capital.
If diversified shareholders are no longer the cheapest risk-bearers, then the associated agency costs may now be voluntary; and, if risk management can substitute for risk capital, without requiring a transfer of ownership, then why go public at all? Do more complete capital markets herald (once again) the eclipse of the public corporation? We offer some preliminary responses, suggesting that the line between public and private firms may begin to blur as the traditional balance between agency costs and the benefits of public ownership shifts towards a new equilibrium. For some, the benefits of public ownership may continue to outweigh the associated agency costs. For others, changes in risk transfer may implicate how a firm is (or should be) governed. The Essay then ends with a final question: If the opportunity to invest in common stock recedes, by what means will former investors in public equity be able to invest capital?
303. Wireless Carterfone, (Wu, Tim)
International Journal of Communication, Vol. 1, P. 389, 2007
Over the next decade, regulators will spend increasing time on the conflicts between the private interests of the wireless industry and the public's interest in the best uses of its spectrum. This report examines the practices of the wireless industry with an eye toward understanding their influence on innovation and consumer welfare.
This report finds a mixed picture. The wireless industry, over the last decade, has succeeded in bringing wireless telephony at competitive prices to the American public. Yet at the same time we also find the wireless carriers aggressively controlling product design and innovation in the equipment and application markets, to the detriment of consumers. Their policies, in the wired world, would be considered outrageous, in some cases illegal, and in some cases simply misguided.
304. Law and the Market: The Impact of Enforcement (Coffee, John C. Jr.)
The intensity of enforcement efforts by securities regulators varies widely among financially developed nations, but countries with “common law origins” systematically expend more on securities regulation than countries with “civil law origins.” Better than alleged differences in substantive law, the enforcement variable may explain the greater financial development of countries with common law origins. Even more striking than this disparity between “common law” and “civil law” countries, however, is the outlier position of the , whose public and private enforcement efforts dwarf those of other nations.
The is unique not in its expenditures on securities regulation, but in the amount and severity of the penalties it imposes. Enforcement efforts can be sensibly measured either in terms of “inputs” (i.e., budget and staff size) or outputs (i.e., enforcement actions brought or financial sanctions levied). After adjustment for market size or GDP, the does not differ materially from other common law countries in its expenditures, but it brings far more enforcement actions and imposes far greater financial penalties. For example, in 2005/06, the financial penalties imposed by the SEC exceeded those imposed by the ’s Financial Services Agency (“FSA”) by a thirty to one ratio, which, even after adjustment for differences in market capitalization, still translates into a ten to one ratio. Moreover, the SEC is only one of a number of federal and state agencies enforcing securities regulation in the , while the FSA is the ’s integrated regulatory agency covering all financial services, not simply securities. The greater emphasis on enforcement in the is also evident in a comparison of the budgets of the major securities regulators, with the SEC devoting a percentage of its budget to enforcement that more than doubles that of the other major securities regulators. Behind this varying emphasis on enforcement may lie different approaches to regulation: “ex ante” advisory and consulting approach elsewhere and an “ex post,” deterrence-oriented emphasis in the .
The greater use of public enforcement in the is more than paralleled by corresponding disparities in private enforcement and the use of the criminal sanction. Virtually alone, the recognizes the class action and the contingent fee. The actual financial sanctions imposed by private enforcement in the exceed those imposed by public enforcement, and the margin appears to be increasing. In 2005, $11.5 billion was paid by defendants in securities class action settlements and SEC fines, of which total SEC penalties accounted for $1.8 billion (or only 16%). Finally, between 1978 and 2004, some 1,230 years of incarceration and 397.5 years of probation have been imposed by federal courts for crimes involving “financial misrepresentation” (i.e., a small subset of all potential securities laws violations).
What has been the consequence of this greater emphasis on enforcement in the ? Much recent commentary has suggested that it has deterred foreign issuers from entering the and threatened capital market competitiveness. Closer examination suggests, however, that the firms most deterred from cross-listing have been firms with controlling shareholders and a pattern of extracting high private benefits of control. Foreign issuers that do cross-list in the incur a cost of capital reduction averaging 13% and a valuation premium (measured in terms of Tobin’s q) that is 32% greater than that of non-cross-listing firms. Although the cross-listing decision involves a complex interaction of bonding, signaling, self-selection, and reduced informational asymmetry, the overall evidence supports the “bonding hypothesis” and suggests that ’s greater emphasis on enforcement reduces informational asymmetry and gives it a lower cost of equity capital.
Finally, various theories are examined that may explain why “common law” countries—and particularly the —expend greater efforts on enforcement. The implications of this disparity are considered in light of current efforts at cross-border integration of securities regulation.
305. The Cost of Norms: Tax Effects of Tacit Understandings (Raskolnikov, Alex)
Most human interactions take place in reliance on tacit understandings, customary practices, and other legally unenforceable agreements. A considerable literature studying these informal arrangements (commonly referred to as social norms) has a decidedly positive flavor, arguing that many, if not most, of these norms are welfare-enhancing. This Article looks at the less-appreciated darker side of social norms. It combines the analysis of the modern sophisticated tax planning techniques with the existing empirical studies of commercial relationships to reveal a disturbing connection. By relying on tacit understandings rather than express contractual terms, many taxpayers shift some of their tax liabilities to those whose opportunity to take advantage of social norms is more limited or non-existent. The resulting inefficiency and inequity is the social cost of social norms. Reducing this cost, however, turns out to be a challenging task. The Article introduces a tax-focused classification of social norms and singles out the type of norms that are particularly inefficient. Unfortunately, while reducing the use of these norms (or eliminating them altogether) would be welfare-enhancing, it is unlikely to succeed in practice. Indiscriminately attacking all norms is easier administratively, but socially costly. The Article proposes a compromise between these two courses of action that is more administrable than the first approach and less costly than the second. It also offers a guide that would assist the government in identifying particularly inefficient norms.
Keywords: tax policy, tax avoidance, social norms, relational contracts, externalities
306. Paying for Delay: Pharmaceutical Patent Settlement as a Regulatory Design Problem (Hemphill, C. Scott)
New York University Law Review, VOl 81, p. 1553, 2006
Over the past decade, drug makers have settled patent litigation by making large payments to potential rivals who, in turn, abandon suits that (if successful) would increase competition. Because such "pay-for-delay" settlements postpone the possibility of competitive entry, they have attracted the attention of antitrust enforcement authorities, courts, and commentators. Pay-for-delay settlements not only constitute a problem of immense practical importance in antitrust enforcement, but also pose a general dilemma about the proper balance between innovation and consumer access.
This Article examines the pay-for-delay dilemma as a problem in regulatory design. A full analysis of the relevant industry-specific regulatory statute, the Hatch-Waxman Act, yields two conclusions. First, certain features of the Act widen, often by subtle means, the potential for anticompetitive harm from pay-for-delay settlements. Second, the Act reflects a congressional judgment favoring litigated challenges, contrary to arguments employed to justify these settlements. These results support the further conclusion that pay-for-delay settlements are properly condemned as unreasonable restraints of trade. This analysis illustrates two mechanisms by which an industry-specific regulatory regime shapes the scope of antitrust liability: by creating (or limiting) opportunities for anticompetitive conduct as a practical economic matter, and by guiding as a legal matter the vigor of antitrust enforcement in addressing that conduct.
307. Enlisting the Tax Bar (Schizer, David M.)
Published in the Tax Law Review, Vol. 59, No. 3, 2007.
Tax shelters and aggressive planning derive in part from a structural imbalance in our tax system that has not been adequately explored: In important respects, the private tax bar outmatches their counterparts in government. Although a strong policy case can be made for remedying this mismatch, this Article emphasizes two institutional barriers that complicate any solution, rooted in the political economy of taxation and the economics and professional norms of the legal profession. First, although it would be enormously helpful to dramatically increase the staffing levels and pay of government tax administrators, this is a politically daunting task. Second, a fallback strategy is to look to the private bar for help, but they face a significant conflict. Both market pressure and professional norms motivate them to serve their clients, who generally do not have an interest in improving government tax enforcement.
In light of these two challenges, what can be done to mitigate the mismatch between the government and private bar? This Article offers two sets of proposals. First, a number of suggestions focus on the government, offering ways to improve recruiting and reinforce the expertise at their disposal without dramatically increasing funding or raising pay substantially across the board. For example, the government should focus on recruiting senior lawyers out of retirement (whose financial demands will be limited) and having them mentor junior lawyers directly from law school (whose private sector pay is high, but not nearly as high as it will become in later years). The government should also consider a loan forgiveness program for these recent graduates, and should also enlist academics to assist with discrete projects. The government should also retain private law firms to litigate tax controversies with extraordinary precedential value.
Second, this Article offers guidance about the right way (and the wrong way) to tap the expertise and information possessed by the private bar. It is more effective, whenever possible, to ask lawyers to help the government in a way that also helps their clients. Using this principle, this Article identifies promising opportunities that have been overlooked, and critiques unpromising initiatives that have attracted significant government support. For example, clients do not want their own tax deals shut down, but they feel differently about their competitor's deals, so the government should make more systematic use of this opportunity. Likewise, although clients are less motivated to help the government identify bad transactions that are inadvertently permitted, they are highly motivated to identify good transactions that are inadvertently prohibited. As a result, the government can look to the private bar for help in narrowing overbroad anti-abuse measures. On the other hand, in asking tax advisors to disclose their clients' aggressive transactions - in effect, to "rat" on their clients - the government is asking for something that clearly is not in the clients' interest. This reality is likely to undercut this initiative, which has been one of the centerpieces of the government's efforts to date.
308. Learning to Learn: Undoing the Gordian Knot of Development Today (Reddy, Sanjay G. and Charles Sabel)
The deep flaw of existing approaches to development is their dirigisme: the assumption, common to nearly all development theory, that there is an expert agent that already sees the future. A common thread connects the emergent alternatives to development orthodoxy: the enhancement of the conditions of individual and collective learning. This approach to development highlights the existence of unresolved problems and the necessity of problem solving in every sphere. The enhancement of the conditions of learning can be the key to improving performance, resolving deadlocks, and overcoming blockages, at every level at which common dilemmas and collective problem solving occur - from the global commons to the local enterprise.
Keywords: Development, dirigisme, learning, problem solving, democracy
309. Dilution (Long, Clarisa)
Columbia Law Review, Vol. 106, No 5, 2006
Ever since the creation of federal dilution law, legal commentators have expressed consternation about this variation of the trademark entitlement. Prior to the advent of this form of protection, the owner of a mark could recover for trademark infringement under the Lanham Act only if the commercial use of its mark by someone else caused consumer confusion. By contrast, dilution grants trademark holders an injunctive remedy for the use of their famous marks by another even when consumers are not confused. This Article explores how federal dilution law is actually being judicially enforced. To do so, it examines the enforcement rates of dilution claims in reported cases and in unreported trademark filings. The data show that dilution has not been as powerful a theory of infringement as one might expect. Judicial enforcement of dilution law is not robust today and has been eroding over time. Quantitative and qualitative data derived from published opinions and from trademark infringement filings indicate that after a period of initial broad interpretation and sometimes even enthusiastic embrace of dilution law, courts in recent years have become rather chary of it. The Article next examines some reasons why this might be so and why trademark holders have not fully adapted their pleading practices to these developments. The Article then explores some of the implications of the judiciary's treatment of federal dilution law.
Keywords: trademark dilution, intellectual property, Lanham Act, FTDA
310. Keeping the Internet Neutral?: Christopher S. Yoo and Timothy Wu Debate (Yoo, Christopher S. and Tim Wu)
Network neutrality has emerged as one of the highest profile issues in telecommunications and Internet policy last year. Not only did it play a pivotal role in both houses of Congress during debates over proposed communications reform legislation; it also emerged as a key consideration during the Federal Communications Commission consideration of the recent SBC-AT&T, Verizon-MCI, and AT&T-BellSouth mergers. In the following exchange, Professors Christopher Yoo and Tim Wu engage in a lively debate over the merits of network neutrality that reviews the leading arguments on both sides of the issue.