American Law and Economics Review - recent issues

Management Always Wins the Close Ones

Listokin, Y. — 2008-12-17

While much has been made of "shareholder democracy" as a lever of corporate governance, there is little evidence about the efficacy of voting. This paper empirically examines votes on management-sponsored resolutions and finds widespread irregularities in the distribution of votes received by management. Management is overwhelmingly more likely to win votes by a small margin than lose by a small margin. The results indicate that, at some point in the voting process, management obtains highly accurate information about the likely voting outcome and, based on that information, acts to influence the vote. The precise point at which this occurs is unclear, though it is likely to be near the "poll-closing" time. Whatever the cause of management's advantage, it is clear that shareholder voting does not constitute a "representative" direct democracy.

Defense Costs and Insurer Reserves in Medical Malpractice and Other Personal Injury Cases: Evidence from Texas, 1988-2004

Black, B., Hyman, D. A., Silver, C., Sage, W. M. — 2008-12-17

We study defense costs for commercially insured personal injury tort claims in Texas over 1988–2004, and insurer reserves for those costs. We rely on detailed case-level data on defense legal fees and expenses, and Texas state bar data on lawyers’ hourly rates. We study medical malpractice ("med mal") cases in detail, and other types of cases in less detail. Controlling for payouts, real defense costs in med mal cases rise by 4.6 percent per year, roughly doubling over this period. The rate of increase is similar for legal fees and for other expenses. Real hourly rates for personal injury defense counsel are flat. Defense costs in med mal cases correlate strongly with payouts, both in ordinary least squares (OLS) and in an instrumental variable analysis. They also correlate with the stage at which a case is resolved, and case duration. Mean duration declined over time. Med mal insurers predominantly use outside counsel. Case-level variation in initial expense reserves predicts a small fraction of actual defense costs. In other areas of tort litigation (auto, general commercial, multi-peril, and other professional liability), defense costs rose by 2.2 percent per year. Defense costs in these cases are predicted by the same factors as in med mal cases, plus the presence of multiple defendants.

Insurer reserving practices raise some puzzles. Med mal insurers did not react to the sustained rise in defense costs by adjusting their expense reserves, either in real dollars or relative to reserves for payouts. Thus, expense reserves declined substantially relative to defense costs. In other litigation areas, expense reserves rose along with defense costs.

Does Post-Accident Drug Testing Reduce Injuries? Evidence from a Large Retail Chain

Morantz, A. D., Mas, A. — 2008-12-17

This study examines the effects on occupational injury claims of a recently implemented post-accident drug testing (PADT) program in a large retail chain. We find that claims have fallen significantly in affected districts, suggesting that PADT programs can reduce injury claims, even in workplaces that already utilize other forms of drug testing. Our results also suggest that some types of employees—such as full-time workers, male workers, and higher-tenure workers—are particularly responsive. Finally, we find some "circumstantial evidence" that a portion of the observed decline could be caused by employees’ reduced willingness to report workplace accidents.

Bankruptcy Law and Entrepreneurship

Armour, J., Cumming, D. — 2008-12-17

Recent initiatives in a number of countries have sought to promote entrepreneurship through relaxing the legal consequences of personal bankruptcy. Whilst there is an intuitive link, relatively little attention has been paid to the question empirically, particularly in the international context. We investigate the relationship between bankruptcy laws and entrepreneurship using data on self-employment over 16 years (1990–2005) and fifteen countries in Europe and North America. We compile new indices reflecting how "forgiving" personal bankruptcy laws are. These measures vary over time and across the countries studied. We show that bankruptcy law has a statistically and economically significant effect on self-employment rates when controlling for GDP growth, MSCI stock returns, and a variety of other legal and economic factors.

Evidentiary Standards and Information Acquisition in Public Law

Stephenson, M. C. — 2008-12-17

This article considers the type of evidence that an overseer (e.g., a court) should require before allowing a government agent to take some proposed action. The court can increase agency research incentives by prohibiting actions unless the agent produces supporting evidence, and/or by permitting action even when the agent uncovers adverse evidence. The court thus faces a trade-off between an evidentiary standard's ex post effects on the agent's policy decision and its ex ante effects on the agent's incentive to do research. An extension allows the court to make research effort a precondition for action, regardless of the evidence produced.

The Optimal Penalty for Sexually Transmitting HIV

Francis, A. M., Mialon, H. M. — 2008-12-17

We develop an endogenous signaling model of sexual behavior and testing under risk of HIV infection to determine whether current criminal laws against exposure to HIV are efficient and to identify the socially optimal law. We consider a law to be socially optimal if it induces information revelation, so that non-fully-informed HIV transmission does not occur. We find that current HIV-specific criminal laws in the United States, which stipulate a single penalty for knowingly exposing another individual to risk of HIV infection, are not generally optimal. The optimal law stipulates a single penalty for knowingly or unknowingly transmitting HIV, and no penalty for exposing another individual to risk of infection without transmitting the virus. The optimal expected penalty is estimated to be approximately 1–2 years of prison.

The Economics of US Civil War Conscription

Perri, T. J. — 2008-12-17

US conscription in the Civil War is analyzed. Conscription was designed to gain federal control of enlistments, leaving state and local governments much of the fiscal and administrative responsibility for raising troops. Due to the hiring of substitutes, the payment of a fee to avoid service (commutation), and community-provided funds, only 2% of those who served were conscripted. Theory suggests that federal pay and local government bonuses increase as the marginal opposition by citizens to the number of reluctant draftees increases, and commutation could have lowered social cost. Instead, commutation was a binding ceiling on the price of substitutes.

Global Market Surveillance

Cumming, D., Johan, S. — 2008-12-17

This paper provides evidence on market surveillance from exchanges and securities commissions from twenty-five jurisdictions in North, Central and South America, Western and Eastern Europe, Africa, and Asia. Exchanges as SROs engage in a greater range of single-market surveillance of market manipulative practices than securities commissions, but the scope of cross-market surveillance activity is very similar among exchanges and securities commissions. Cross-market surveillance is more effective with information-sharing arrangements, and securities commissions are more likely to engage in information sharing than exchanges are. Relative to the scope of single-market surveillance, the scope of cross-market surveillance shows a stronger positive association with trading velocity, the number of listed companies, and market capitalization. The data also indicate that as at 2005, there is ample scope for jurisdictions to expand their cross-market surveillance and thereby stimulate investor confidence and trading activity.

The Economics of the Bill of Rights

Mialon, H. M., Rubin, P. H. — 2008-05-03

We elucidate, connect, and synthesize the literature that employs economics to study the individual rights and freedoms protected by the constitutional amendments comprising the Bill of Rights, especially as they relate to crime. Economics is uniquely suited to studying decisions involving tradeoffs, and each of the amendments requires tradeoffs. Emphasizing these tradeoffs allows us to discuss the constitutional rights in terms of "more or less," as opposed to taking an absolutist approach. We find that the economic literature on the amendments of the Bill of Rights is vibrant and growing, and that viewing the amendments within the framework of economics is highly useful.

How Important is State Enforcement for Trade?

Leeson, P. T. — 2008-05-03

According to conventional wisdom, state-provided contract enforcement is critical to an expansive, growing trade. This paper estimates state enforcement's impact on international trade for one hundred and fifty-seven countries over the last half a century. I find that state enforcement increases trade between nations by about fifteen to thirty-eight percent. This effect is significant though modest compared to intuition about the importance of government enforcement, the long-run growth of trade, and the estimated effect of trade's other determinants. Thus, while state enforcement appears to enhance trade, it does so less impressively than its status as essential for flourishing trade tends to suggest.

Interpreting Empirical Estimates of the Effect of Corporate Governance

Listokin, Y. — 2008-05-03

Empirical studies of corporate governance address potential endogeneity problems, but fail to place endogeneity in the context of a model and ignore the possibility of disparate treatment effects across companies. This paper tackles these defects. The model and analysis in the paper demonstrate that: (1) Valid and positive estimates for the effect of governance can only arise if there is random variation in governance and governance is systematically underproduced, or governance is chosen randomly without bias and the randomness under study concerns a subpopulation with below-average governance. (2) Governance models that correct for endogeneity using subsamples of firms, fixed effects, or instrumental variables estimates focus on subpopulations of companies that may have different responses to a governance treatment than the average firm.

Case Dismissed: Police Discretion and Racial Differences in Dismissals of Felony Charges

Tomic, A., Hakes, J. K. — 2008-05-03

Prior research has produced conflicting evidence of racial profiling during traffic stops. We instead analyze rates of case dismissal against felony arrestees by race. Superficial bias based on "unobservables" should be reduced because of the evidentiary requirements and nonnegligible costs of filing charges. Nonetheless, using data from over 58,000 US felony cases from 1990 to 1998, our probit analysis finds higher rates of dismissals for blacks for the subset of crimes that rely on police to make snap judgments. This suggests there may be more aggressive policing of blacks in these situations. Case dismissal rates are also elevated for both whites and blacks when blacks are underrepresented on local police forces.

Patent-Secret Mix in Complex Product Firms

Ottoz, E., Cugno, F. — 2008-05-03

Different protection mechanisms may be employed at the same time when an innovation is comprised of separately protectable components. If patents and trade secrets can be mixed in protecting single innovations, a strengthening in patent breadth may induce a lower level of patenting, as innovators are more prone to rely on secrecy.

Guilt Shall Not Escape or Innocence Suffer? The Limits of Plea Bargaining When Defendant Guilt is Uncertain

Bjerk, D. — 2007-10-26

This article examines optimal prosecutor behavior with respect to plea bargaining when defendant guilt is uncertain. I show that when jury beliefs and behavior are determined endogenously in equilibrium along with defendant and prosecutor behavior, plea bargaining can play only a limited role in managing society's conflicting desires to maximize punishment of the guilty and minimize punishment of the falsely accused. In particular, while it can be optimal for prosecutors to use plea bargaining to induce a large fraction of guilty defendants to voluntarily sort themselves from the innocent, such sorting must come at the cost of imposing relatively short sentences on such guilty defendants who accept plea bargains.

Tort Liability Litigation Costs for Commercial Claims

Hersch, J., Viscusi, W. K. — 2007-10-26

This article analyzes tort liability litigation costs using the Texas Department of Insurance Commercial Liability Insurance Closed Claim database for the years 1988–2004. Insurer costs to defend claims in which a suit was filed average $35,000 per claim in 2004$, which corresponds to a share of 0.18 of total expenditures. Claims with higher stakes and complexity lead to greater reliance on outside counsel and less reliance on in-house counsel. Total transactions costs for each dollar received by claimants average $0.75 for all claims and $0.83 for claims in which the claimant retained an attorney and a suit was filed.

Bundled Discounts, Leverage Theory, and Downstream Competition

Simpson, J., Wickelgren, A. L. — 2007-10-26

Under plausible circumstances, a monopolist in one market can use its control of prices in that market to force competing downstream buyers to sign tying contracts that will lever its monopoly into another market. Specifically, the monopolist of the tying good can place each downstream buyer in a prisoner's dilemma by offering them more favorable pricing on the tying good if they sign a requirements-tying contract covering the tied good. Since a buyer benefits on receiving more favorable pricing on the tying good and the competitors do not, and suffers if the competitors receive more favorable pricing on the tying good and the buyer does not, buyers will sign the tying contract even when they would earn higher profits if they all refused to sign. This enables a monopolist in one market to inefficiently exclude an entrant in another market.

Amended Final-offer Arbitration Outperforms Final-offer Arbitration

Deck, C., Farmer, A., Zeng, D.-Z. — 2007-10-26

Amended final-offer arbitration (AFOA) has been developed as an attractive alternative mechanism to final-offer arbitration (FOA). Under AFOA, more reasonable offers win, but the outcome is determined by the loser's offer and the arbitrator's value. In AFOA, disputants making extreme offers are penalized, thereby encouraging compromise. This article compares the theoretical and behavioral properties of AFOA and FOA. Controlled laboratory experiments indicate that AFOA significantly outperforms FOA, generating substantially greater prearbitration settlement. Consistent with theoretical predictions, offers converge under AFOA; however, FOA offers neither converge nor are consistent with theoretical predictions. This work suggests practitioners should consider adopting AFOA over FOA.

Successor Liability and Asymmetric Information

Choi, A. H. — 2007-10-26

The doctrine of successor liability transfers tort liability arising from the seller's past conduct from the seller to the buyer. If the buyer has as much information about the liability as the seller, all beneficial acquisitions take place and the seller takes the efficient level of precaution. However, if the seller has more information about the liability than the buyer, not all beneficial acquisitions are consummated and the seller takes a suboptimal level of precaution. I argue that, in the presence of information asymmetry, the courts should increase the damages against the (potential) seller to provide better incentives to take precaution while decreasing the damages against the buyer to encourage more beneficial asset sales.