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Article

“Antitrust” or “competition law,” a set of policies now existing in most market economies, largely consists of two or three specific rules applied in more or less the same way in most nations. It prohibits (1) multilateral agreements, (2) unilateral conduct, and (3) mergers or acquisitions, whenever any of them are judged to interfere unduly with the functioning of healthy markets. Most jurisdictions now apply or purport to apply these rules in the service of some notion of economic “efficiency,” more or less as defined in contemporary microeconomic theory. The law has ancient roots, however, and over time it has varied a great deal in its details. Moreover, even as to its modern form, the policy and its goals remain controversial. In some sense most modern controversy arises from or is in reaction to the major intellectual reconceptualization of the law and its purposes that began in the 1960s. Specifically, academic critics in the United States urged revision of the law’s goals, such that it should serve only a narrowly defined microeconomic goal of allocational efficiency, whereas it had traditionally also sought to prevent accumulation of political power and to protect small firms, entrepreneurs, and individual liberty. While those critics enjoyed significant success in the United States, and to a somewhat lesser degree in Europe and elsewhere, the results remain contested. Specific disputes continue over the law’s general purpose, whether it poses net benefits, how a series of specific doctrines should be fashioned, how it should be enforced, and whether it really is appropriate for developing and small-market economies.

Article

In the wake of the 2008 financial collapse, clearinghouses have emerged as critical players in the implementation of the post-crisis regulatory reform agenda. Recognizing serious shortcomings in the design of the over-the-counter derivatives market for swaps, regulators are now relying on clearinghouses to cure these deficiencies by taking on a central role in mitigating the risks of these instruments. Rather than leave trading firms to manage the risks of transacting in swaps privately, as was largely the case prior to 2008, post-crisis regulation requires that clearinghouses assume responsibility for ensuring that trades are properly settled, reported to authorities, and supported by strong cushions of protective collateral. With clearinghouses effectively guaranteeing that the terms of a trade will be honored—even if one of the trading parties cannot perform—the market can operate with reduced levels of counterparty risk, opacity, and the threat of systemic collapse brought on by recklessness and over-complexity. But despite their obvious benefit for regulators, clearinghouses also pose risks of their own. First, given their deepening significance for market stability, ensuring that clearinghouses themselves operate safely represents a matter of the highest policy priority. Yet overseeing clearinghouses is far from easy and understanding what works best to undergird their safe operation can be a contentious and uncertain matter. U.S. and EU authorities, for example, have diverged in important ways on what rules should apply to the workings of international clearinghouses. Secondly, clearinghouse oversight is critical because these institutions now warehouse enormous levels of counterparty risk. By promising counterparties across the market that their trades will settle as agreed, even if one or the other firm goes bust, clearinghouses assume almost inconceivably large and complicated risks within their institutions. For swaps in particular—whose obligations can last for months, or even years—the scale of these risks can be far more extensive than that entailed in a one-off sale or a stock or bond. In this way, commentators note that by becoming the go-to bulwark against risk-taking and its spread in the financial system, clearinghouses have themselves become the too-big-to-fail institution par excellence.

Article

A patent is a legal right to exclude granted by the state to the inventor of a novel and useful invention. Much legal ink has been spilled on the meaning of these terms. “Novel” means that the invention has not been anticipated in the art prior to its creation by the inventor. “Useful” means that the invention has a practical application. The words “inventor” and “invention” are also legal terms of art. An invention is a work that advances a particular field, moving practitioners forward not simply through accretions of knowledge but through concrete implementations. An inventor is someone who contributes to an invention either as an individual or as part of a team. The exclusive right, finally, is not granted gratuitously. The inventor must apply and go through a review process for the invention. Furthermore, a price for the patent being granted is full, clear disclosure by the inventor of how to practice the invention. The public can use this disclosure once the patent expires or through a license during the duration of the patent. These institutional details are common features of all patent systems. What is interesting is the economic justification for patents. As a property right, a patent resolves certain externality problems that arise in markets for knowledge. The establishment of property rights allows for trade in the invention and the dissemination of knowledge. However, the economic case for property rights is made complex because of the institutional need to apply for a patent. While in theory, patent grants could be automatic, inventions must meet certain standards for the grant to be justified. These procedural hurdles create possibilities for gamesmanship in how property rights are allocated. Furthermore, even if granted correctly, property rights can become murky because of the problems of enforcement through litigation. Courts must determine when an invention has been used, made, or sold without permission by a third party in violation of the rights of the patent owner. This legal process can lead to gamesmanship as patent owners try to force settlements from alleged infringers. Meanwhile, third parties may act opportunistically to take advantage of the uncertain boundaries of patent rights and engage in undetectable infringement. Exacerbating these tendencies are the difficulties in determining damages and the possibility of injunctive relief. Some caution against these criticisms through the observation that most patents are not enforced. In fact, most granted patents turn out to be worthless, when gauged in commercial value. But worthless patents still have potential litigation value. While a patent owner might view a worthless patent as a sunk cost, there is incentive to recoup investment through the sale of worthless patents to parties willing to assume the risk of litigation. Hence the phenomenon of “trolling,” or the rise of non-practicing entities, troubles the patent landscape. This phenomenon gives rise to concerns with the anticompetitive uses of patents, demonstrating the need for some limitations on patent enforcement. With all the policy concerns arising from patents, it is no surprise that patent law has been ripe for reform. Economic analysis can inform these reform efforts by identifying ways in which patents fail to create a vibrant market for inventions. Appreciation of the political economy of patents invites a rich academic and policy debate over the direction of patent law.

Article

Corporate governance includes legal, contractual, and market mechanisms that structure decision-making within business corporations. Most attention has focused on corporate governance in large U.S. public corporations with dispersed shareholding. The separation of ownership from control in those corporations creates a unique problem, as shareholders typically have weak individual incentive to monitor managers. Mechanisms that have been developed to address this agency problem include independent directors, fiduciary duty, securities law disclosure, executive compensation, various professional gatekeepers, the market for corporate control, and shareholder activism. In most countries outside the United States, there are few companies with dispersed shareholding. Instead, most companies have a controlling shareholder or group. These companies face a different agency problem, the possibility that controlling shareholders may use their power to gain at the expense of minority shareholders. Enterprise governance refers to mechanisms aimed at related agency problems that occur in closely held companies without publicly traded equity interests. Here too the agency problem typically encountered is the potential conflict between controllers and minority investors, with the added twist that share illiquidity removes an important protection for the minority. Closely held companies have adopted a variety of contractual mechanisms to address these concerns. Other than the important but special cases of venture capital and private equity fund investments, there is less empirical evidence on governance in closely held companies because information is generally much harder to find.

Article

Antony W. Dnes

Economists increasingly connect legal changes to behavioral responses that many family law experts fail to see. Incentives matter in families, which respond to changes in legal regulation. Changing incentive structures linked to family law have largely affected marriage, cohabitation, and divorce. Economic analysis has been applied to assess the causes of falling marriage rates and delays in marriage. Much analysis has focused on increases in divorce rates, which appear to respond to legal changes making divorce easier, and to different settlement regimes. Less work has been done in relation to children but some research does exist showing how children are impacted by changes in incentives affecting adults.

Article

Without copyright law, authors would be unable to internalize the benefits of their writings. Copyright law reacts to this by providing authors with a period of exclusivity. The relevant legislation has a contract-like character; authors receive a period of exclusivity, and the public benefits by virtue of original writings that eventually pass into the public domain. Ideally each contract between the public and an author would be individually negotiated. Because U.S. copyright law is strictly utilitarian, authors would be “paid” the lowest amount possible to bring their works into existence. For example, popular authors may be able to internalize sufficient returns in just a few years. In other cases, a longer period of exclusivity is necessary. Huge transaction costs prohibit individual transactions and, at this writing, most works are protected for the life of the author plus 70 years. As an economic matter, the actual implementation of copyright law is hard to rationalize. Works with even a modicum of creativity are copyrightable. This can result in a disincentive to be creative and invites expensive legal disputes about works that are socially irrelevant. In addition, works receive levels of protection that are independent of their value to the public. In some instances Congress with the approval of the Supreme Court has extended the copyright term for works already in existence. Retroactive extension of the copyright term cannot have an impact on works in existence. Oddly, copyright law views authors as profit maximizers but also limits the value of their works by allowing heirs to terminate assignments after a set period of time. Finally, the remedy for copyright infringement is the damages suffered by the author plus all profits made by the infringer that can be traced to the infringement. It is not clear that this remedy is consistent with the goals of copyright law.

Article

Keith N. Hylton

Criminal law consists of substantive and procedural parts. Substantive law is the set of rules defining conduct that violates the law. Procedural criminal law is the set of rules regulating the process of punishment. Substantive rules apply mostly to individual actors, and procedural rules apply to public enforcement agencies and adjudicators. Economic theory of criminal law consists of normative and positive parts. Normative economic theory, which began with writings by Beccaria and Bentham, aims to recommend an ideal criminal punishment scheme. Positive economic theory, which appeared later in writings by Holmes and Posner, aims to justify and to better understand the criminal law rules that exist. Since the purpose of criminal law is to deter socially undesirable conduct, economic theory, which emphasizes incentives, would appear to be an important perspective from which to examine criminal law. Positive economic theory, applied to substantive criminal law, seeks to explain and to justify criminal law doctrine in economic terms—that is, in terms that emphasize the incentive effects created by the law. The positive economic theory of criminal law literature can be divided into three phases: Classical deterrence theory, neoclassical deterrence, and modern synthesis. The modern synthesis provides a rationale for fundamental criminal law doctrines and also more puzzling portions of the law such as the doctrines of intent and necessity. Positive economic theory also provides a rationale for the allocation of enforcement responsibilities.

Article

Insider trading is not widely understood. Insiders of corporations can, in fact, buy and sell shares of those corporations. But, over time, Congress, the courts and the Securities and Exchange Commission (SEC) have imposed significant limits on such trading. The limits are not always clearly marked and the principles underlying them not always consistent. The core principle is that it is illegal to trade if one is in the possession of material, nonpublic information. But the rationality of this principle has been challenged by successive generations of law and economics scholars, most notably Manne, Easterbrook, Epstein, and Bainbridge. Their “economic” analysis of this contested area of the law provides, arguably, at least a more consistent basis upon which to decide when trades by insiders should, in fact, be disallowed. A return to genuine “first principles” generated by the nature of capitalism, however, allows for more powerful insights into the phenomenon and could lead to more effective regulation.

Article

Joni Hersch and Blair Druhan Bullock

The labor market is governed by a panoply of laws, regulating virtually all aspects of the employment relation, including hiring, firing, information exchange, privacy, workplace safety, work hours, minimum wages, and access to courts for redress of violations of rights. Antidiscrimination laws, especially Title VII, notably prohibit employment discrimination on the basis of race, color, religion, sex, and national origin. Court decisions and legislation have led to the extension of protection to a far wider range of classes and types of workplace behavior than Title VII originally covered. The workplace of the early 21st century is very different from the workplace when the major employment discrimination statutes were enacted, as these laws were conceived as regulating an employer–employee relationship in a predominantly white male labor market. Prior emphasis on employment discrimination on the basis of race and sex has been superseded by enhanced attention to sexual harassment and discrimination on the basis of disability, sexual orientation, gender identity, and religion. Concerns over the equity or efficiency of the employment-at-will doctrine recede in a workforce in which workers are increasingly categorized as independent contractors who are not covered by most equal employment laws. As the workplace has changed, the scholarship on the law and economics of employment law has been slow to follow.

Article

While economists overwhelmingly favor free trade, even unilateral free trade, because of the gains realizable from specialization and the exploitation of comparative advantage, in fact international trading relations are structured by a complex body of multilateral and preferential trade agreements. The article outlines the case for multilateral trade agreements and the non-discrimination principle that they embody, in the form of both the Most Favored Nation principle and the National Treatment principle, where non-discrimination has been widely advocated as supporting both geopolitical goals (reducing economic factionalism) and economic goals (ensuring the full play of theories of comparative advantage undistorted by discriminatory trade treatment). Despite the virtues of multilateral trade agreements, preferential trade agreements (PTAs), authorized from the outset under GATT, have proliferated in recent years, even though they are inherently discriminatory between members and non-members, provoking vigorous debates as to whether (a) PTAs are trade-creating or trade-diverting; (b) whether they increase transaction costs in international trade; and (c) whether they undermine the future course of multilateral trade liberalization. A further and similarly contentious derogation from the principle of non-discrimination under the multilateral system is Special and Differential Treatment for developing countries, where since the mid-1950s developing countries have been given much greater latitude than developed countries to engage in trade protectionism on the import side in order to promote infant industries, and since the mid-1960s on the export side have benefited from non-reciprocal trade concessions by developed countries on products of actual or potential export interest to developing countries. Beyond debates over the strengths and weaknesses of multilateral trade agreements and the two major derogations therefrom, further debates surround the appropriate scope of trade agreements, and in particular the expansion of their scope in recent decades to address divergences or incompatibilities across a wide range of domestic regulatory and related policies that arguably create frictions in cross-border trade and investment and hence constitute an impediment to it. The article goes on to consider contemporary fair trade versus free trade debates, including concerns over trade deficits, currency manipulation, export subsidies, misappropriation of intellectual property rights, and lax labor or environmental standards. The article concludes with a consideration of the case for a larger scope for plurilateral trade agreements internationally, and for a larger scope for active labor market policies domestically to mitigate transition costs from trade.

Article

Nuno Garoupa

Law and economics is an important, growing field of specialization for both legal scholars and economists. It applies efficiency analysis to property, contracts, torts, procedure, and many other areas of the law. The use of economics as a methodology for understanding law is not immune to criticism. The rationality assumption and the efficiency principle have been intensively debated. Overall, the field has advanced in recent years by incorporating insights from psychology and other social sciences. In that respect, many questions concerning the efficiency of legal rules and norms are still open and respond to a multifaceted balance among diverse costs and benefits. The role of courts in explaining economic performance is a more specific area of analysis that emerged in the late 1990s. The relationship between law and economic growth is complex and debatable. An important literature has pointed to significant differences at the macro-level between the Anglo-American common law family and the civil law families. Although these initial results have been heavily scrutinized, other important subjects have surfaced such as convergence of legal systems, transplants, infrastructure of legal systems, rule of law and development, among others.

Article

David A. Hyman and Charles Silver

Medical malpractice is the best studied aspect of the civil justice system. But the subject is complicated, and there are heated disputes about basic facts. For example, are premium spikes driven by factors that are internal (i.e., number of claims, payout per claim, and damage costs) or external to the system? How large (or small) is the impact of a damages cap? Do caps have a bigger impact on the number of cases that are brought or the payment in the cases that remain? Do blockbuster verdicts cause defendants to settle cases for more than they are worth? Do caps attract physicians? Do caps reduce healthcare spending—and by how much? How much does it cost to resolve the high percentage of cases in which no damages are recovered? What is the comparative impact of a cap on noneconomic damages versus a cap on total damages? Other disputes involve normative questions. Is there too much med mal litigation or not enough? Are damage caps fair? Is the real problem bad doctors or predatory lawyers—or some combination of both? This article summarizes the empirical research on the performance of the med mal system, and highlights some areas for future research.

Article

Tort law is part of the common law that originated in England after the Norman Conquest and spread throughout the world, including to the United States. It is judge-made law that allows people who have been injured by others to sue those who harmed them and collect damages in proper cases. Since its early origins, tort law has evolved considerably and has become a full-fledged “grown order,” like the economy, and can best be understood by positive theory, also like the economy. Economic theories of tort have developed since the early 1970s, and they too have evolved over time. Their objective is to generate fresh insight about the purposes and the workings of the tort system. The basic thesis of the economic theory is that tort law creates incentives for people to minimize social cost, which is comprised of the harm produced by torts and the cost of the precautions necessary to prevent torts. This thesis, intentionally simple, generates many fresh insights about the workings and effects of the tort system and even about the actual legal rules that judges have developed. In an evolved grown order, legal rules are far less concrete than most people would expect though often very clear in application. Beginning also in the 1970s, legal philosophers have objected to the economic theory of tort and have devised philosophical theories that compete. The competition, moreover, has been productive because it has spurred both sides to revise and improve their theories and to seek better to understand the law. Tort law is diverse, applicable to many different activities and situations, so developing a positive theory about it is both challenging and rewarding.

Article

Longstanding international frictions over uneven levels of protection granted to intellectual property rights (IPR) in different parts of the world culminated in 1995 in the form of the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)—a multilateral trade agreement that all member countries of the World Trade Organization (WTO) are obligated to follow. This landmark agreement was controversial from the start since it required countries with dramatically different economic and technological capabilities to abide by essentially the same rules and regulations with respect to IPRs, with some temporary leeway granted to developing and least developed countries. As one might expect, developing countries objected to the agreement on philosophical and practical grounds while developed countries, especially the United States, championed it strongly. Over the years, a vast and rich economics literature has emerged that helps understand this international divide. More specifically, several fundamental issues related to the protection of IPRs in the global economy have been addressed: are IPRs trade-related? Do the incentives for patent protection of an open economy differ from those of a closed one and, if so, why? What is the rationale for international coordination over national patent policies? Why do developed and developing countries have such radically different views regarding the protection of IPRs? What is the level of empirical support underlying the major arguments for and against the TRIPS-mandated strengthening of IPRs in the world economy? Can the core obligations of the TRIPS Agreement as well as the flexibilities it contains be justified on the basis of economic logic? We discuss the key conclusions that can be drawn from decades of rigorous theoretical and empirical research and also offer some suggestions for future work.

Article

Used for hundreds of years and adapted to a variety of contexts, arbitration is a form of adjudicative dispute settlement where parties consent to selecting third-party neutrals that resolve a specific dispute by applying the applicable law to the facts. Part of arbitration’s success involves its flexibility in adapting procedures and selecting applicable law to meet parties’ unique needs, including having some control over the appointment of an arbitrator who may have unique substantive expertise. Parties may agree to arbitration hoping to avoid the time-consuming, expensive, and complex process of litigation by streamlining or tailoring dispute mechanics. Yet, it is not empirically verifiable that arbitration always saves time and costs, as assessing relative savings requires comparison to a national court and there are over 190 national judiciaries to which arbitration could be compared, as well as nonadjudicative forms of dispute resolution like direct negotiation and mediation. As parties inevitably negotiate in the “shadow of the law,” arbitration aids the assessment of conflict management options; and, particularly internationally, arbitration remains a powerful tool that incentivizes voluntary compliance with awards and streamlines enforcement. Despite the availability of many types of arbitration with different policy considerations, the parties’ consent to it and their agreement to arbitrate (including the applicable law) is the backbone of this form of dispute settlement. Arbitration agreements require parties to make core choices, such as deciding on the scope of agreements submitted to arbitration, the legal place of arbitration, and applicable rules. Such an agreement then provides the framework for fundamental elements of the proceedings, namely, the basis of the tribunal’s jurisdiction and power over the dispute, the standards for appointing arbitrators, the structure and rules of the proceedings, and the content and form of derivative awards. Having a valid arbitration agreement (and an arbitration proceeding conducted in accordance with those legal obligations) also influences whether courts at the place of arbitration will set the award aside and whether courts at a place of enforcement will recognize and enforce an arbitration award. In the modern era, arbitration will continue evolving to address concerns about local policy considerations (particularly in national arbitration), confidentiality and ethics, technology and cybersecurity, diversity and inclusion, and to ensure arbitration is an ongoing value proposition.

Article

Law and economics has proved a particularly fruitful scholarly approach in the field of mergers and acquisitions. A huge law and economics literature has developed, providing critical insights into merger activity in general and the proper role of corporate and securities law in regulating this activity. Early economic research examined the motivations for merger activity and the antitrust implications of mergers. Later scholarship elucidated the important disciplining effects on management from merger activity and the market for corporate control. If management performs poorly, causing a firm to become undervalued relative to a well-managed firm, the firm becomes vulnerable to a takeover where management will be replaced. This prospect provides a powerful incentive for management to perform well. More recent work has revealed the limitations of market discipline on management actions in the merger context, and the corresponding role of corporate law in protecting stockholders. Because a merger is generally the final interaction between management and the other stakeholders in a firm, the typical constraints and mechanisms of accountability that otherwise constrain managerial opportunism may be rendered ineffective. This work has played a central role in informing modern jurisprudence. It has shaped the application of enhanced judicial scrutiny of management actions in the merger context, as embodied in the landmark Delaware cases Unocal and Revlon. The law and economics literature has also made important contribution to more recent developments in stockholder appraisal. The law and economics tradition has also provided a useful framework for evaluating the dynamics of merger litigation, including stockholder appraisal, and the extent to which such litigation can be made to serve a useful role in corporate governance.