Showing papers in "Journal of Law Economics & Organization in 1999"
••
TL;DR: The authors investigated empirically the determinants of the quality of governments in a large cross-section of countries and found that countries that are poor, close to the equator, ethnolinguistically heterogeneous, use French or socialist laws, or have high proportions of Catholics or Muslims exhibit inferior government performance.
Abstract: We investigate empirically the determinants of the quality of governments in a large cross-section of countries. We assess government performance using measures of government intervention, public sector efficiency, public good provision, size of government, and political freedom. We find that countries that are poor, close to the equator, ethnolinguistically heterogeneous, use French or socialist laws, or have high proportions of Catholics or Muslims exhibit inferior government performance. We also find that the larger governments tend to be the better performing ones. The importance of (reasonably) exogenous historical factors in explaining the variation in government performance across countries sheds light on the economic, political, and cultural theories of institutions.
5,555 citations
••
TL;DR: This paper examined public bureaucracy through the lens of transaction cost economics, according to which the public bureaucracy, like other alternative modes of governance, is well suited to some transactions and poorly suited to others.
Abstract: The public bureaucracy is a puzzle. How is it that an organizational form that is so widely used is also believed to be inefficient—both in relation to a hypothetical ideal and in comparison with private bureaucracies? This article examines public bureaucracy through the lens of transaction cost economics, according to which the public bureaucracy, like other alternative modes of governance, is well suited to some transactions and poorly suited to others. Rather than proceed in a completely general way, I focus on what James Q. Wilson describes as “sovereign transactions,” of which foreign affairs is an example. I ask what it is that distinguishes sovereign transactions, after which I compare the efficacy of public and private bureaucracies for managing such transactions. I conclude that there is an efficiency place for public bureaucracy, but that all modes of governance (markets, hybrids, firms, regulation), of which public bureaucracy is one, need to be kept in their place. I further observe that public bureaucracies are not all of a kind and that differences between them need to be distinguished. The public bureau has had a mixed reputation within economics. At the one extreme is the older and resilient (but increasingly discredited) public finance tradition, where public agencies (and the government to which they report) are treated as “omnipotent, omniscient, and benevolent” instruments (Dixit, 1996:8). 1 The property rights view—that the public agency is a haven for inef
747 citations
••
TL;DR: It is asserted that decision rights in organizations are not contractible: the boss can always overturn a subordinate's decision, so formal authority resides only at the top, and the implications of formal delegation achieved through divestitures are explored.
Abstract: We assert that decision rights in organizations are not contractible: the boss can always overturn a subordinate's decision, so formal authority resides only at the top. Although decision rights cannot be formally delegated, they might be informally delegated through self-enforcing relational contracts. We examine the feasibility of informal authority in two informational environments. We show that different information structures produce different decisions not only because different information is brought to bear in the decision-making process, but also because different information creates different temptations to renege on relational contracts. In addition, we explore the implications of formal delegation achieved through divestitures. Authority is the defining feature of hierarchy. The boss can restrict the subordinate's actions, overturn his decisions, and even fire him (unless the boss's boss objects, in which case the boss herself may be fired). Tracing this chain of authority up the hierarchy, we eventually reach a person (sole proprietor) or group (shareholders) who can be thought of as owning all the decision rights in the organization. In short, formal authority resides at the top. Of course, few organizations are run by tyrants who actively exercise their ownership of all the decision rights in the organization. To the contrary, many middle managers wield substantial authority. But we assert that such authority is always informal, in the sense that it can be retracted by those higher up the hierarchy, ultimately by those at the top who hold the formal authority. That is, we see all subordinates' decision rights as loaned, not owned. Given that formal authority resides at the top of organizations, when and how will bosses delegate informal authority to subordinates? To begin to study these questions, we construct a simple model in which a subordinate develops a project to propose to a boss. The boss has the formal authority over whether to ratify the project (i.e., over whether to allow the project to be implemented), but the boss may informally delegate this ratification authority to the subordinate. We see this ratification decision as a metaphor for a wide range of decisions
465 citations
••
TL;DR: In this article, the authors explore the economic role of the firm in a market economy and argue that the Hart-Moore model can only explain why individuals own assets, but not why firms own assets.
Abstract: This article explores the economic role of the firm in a market economy. The analysis begins with a discussion and critique of the property rights approach to the theory of the firm as exposited in the recent work by Hart and Moore (“Property Rights and the Nature of the Firm”). It is argued that the Hart–Moore model, taken literally, can only explain why individuals own assets, but not why firms own assets. In particular, the logic of the model suggests that each asset should be free standing in order to provide maximal flexibility for the design of individual incentives. These implications run counter to fact. One of the key features of the modern firm is that it owns essentially all the productive assets that it employs. Employees rarely own any assets; they only contribute human capital. Why is the ownership of assets clustered in firms? This article outlines an answer based on the notion that control over physical assets gives control over contracting rights to those assets. Metaphorically, the firm is viewed as a miniature economy, an “island” economy, in which asset ownership conveys the CEO the power to define the “rules of the game,” that is, the ability to restructure the incentives of those that accept to do business on (or with) the island. The desire to regulate trade in this fashion stems from contractual externalities characteristic of imperfect information environments. The inability to regulate all trade through a single firm stems from the value of exit rights as an incentive instrument and a tool to discipline the abuse of power.
408 citations
••
TL;DR: In this article, the authors examine how Vietnam's firms use ongoing relationships to maintain agreements and find that these relationships serve to reduce the transaction costs of the market: the costs of locating trading partners, of negotiating and monitoring contracts, and of enforcing agreements and settling disputes.
Abstract: Vietnam's firms contract without the shadow of the law and only partly in the shadow of the future. Although contracting rests in part on the threat of loss of future business, firms often are willing to renegotiate following a breach, so the retaliation is not as forceful as in the standard repeated-game story and not as effective a sanction. To ensure agreements are kept, firms rely on other devices to supplement repeated-game incentives. Firms scrutinize their trading partners. Community sanctions are occasionally invoked. Transactions with greater risk of reneging are supported by more elaborate governance structures. Ongoing relationships among firms serve to reduce the transaction costs of the market: the costs of locating trading partners, of negotiating and monitoring contracts, and of enforcing agreements and settling disputes. In an economy in the midst of deep reform, transaction costs are especially severe because the normal market-supporting institutions are still being built. We examine in this article how Vietnam's firms use ongoing relationships to maintain agreements. For a snapshot of an economy in the process of building institutions, we use a 1995-1997 survey of privately owned manufacturing firms in Hanoi and Ho Chi Minh City. The new ways of doing business in Vietnam have been devised at ground level. The bottom-up reform process has relied on de facto decentralization of economic activity, while leaving in place the formal institutions of central planning. Although Vietnam's government has introduced few policies to foster the private sector, "the owners of private business have worked out their own ad hoc strategy for economic development which is popular, oral rather than in the
292 citations
••
TL;DR: In this article, the authors argue that presidents have incentives to push this ambiguity relentlessly to expand their own powers and that, for reasons rooted in the nature of their institutions, neither Congress nor the courts are likely to stop them.
Abstract: In this article we highlight a formal basis for presidential power that has gone largely unappreciated to this point, but has become so pivotal to presidential leadership and so central to an understanding of presidential power that it virtually defines what is distinctively modern about the modern presidency. This is the president’s formal capacity to act unilaterally and thus to make law on his own. Our central purpose is to set out a theory of this aspect of presidential power. We argue that the president’s powers of unilateral action are a force in American politics precisely because they are not specified in the Constitution. They derive their strength and resilience from the ambiguity of the contract. We also argue that presidents have incentives to push this ambiguity relentlessly to expand their own powers—and that, for reasons rooted in the nature of their institutions, neither Congress nor the courts are likely to stop them. We are currently in the midst of a research project to collect comprehensive data for testing this theory—data on what presidents have done, as well as on how Congress and the courts have responded. Here we provide a brief history of unilateral action, with special attention to the themes of our theoretical argument. We also make use of some early data to emerge from our project. For now it appears that the theory is well supported by the available evidence. This is a work in progress, however, and more is clearly needed before definitive conclusions can be justified. A few observations about politics are so widely accepted that virtually all political scientists have committed them to memory. One of these is Richard Neustadt’s (1960) famous dictum, “Presidential power is the power to persuade,” which expresses, in shorthand form, his view that the powers of the modern American presidency are rooted in the personal qualities of the individual occupying the office—in his skills, his temperament, and his experience. This notion of the personal presidency dominated the field for decades, but its influence is on the decline. The main reason is that it seems increasingly out of sync with the facts. The personal presidency became a popular theoretical notion just as the American presidency was experiencing tremendous growth c
287 citations
••
TL;DR: This article examined monetary compensation and its composition between base salary and bonus, and the associated incentive structures, in the U.S. hospital industry, finding that for-profit hospitals utilize compensation mechanisms that, by involving larger contingent components, provide stronger incentives and greater rewards for performance that is more easily monitored.
Abstract: Differential economic behavior of for-profit and nonprofit institutions can be manifest in both output and input markets. When behavior in output markets is difficult to observe, behavior in input markets can be useful proxies. We examine monetary compensation and its composition between base salary and bonus, and the associated incentive structures, in the U.S. hospital industry. Our data permit controlling for interinstitutional differences in the scope and complexity of jobs having the same titles, as well as differences in organization size and other variables. We find (1) total monetary compensation for the two top executive jobs is substantially higher in the for-profit sector; and (2) the composition of compensation as between base salary and bonus differs materially across forms of organization, bonuses being absolutely and relatively greater in the for-profit sector. Particularly noteworthy is the finding that for-profit hospitals utilize compensation mechanisms that, by involving larger contingent components, provide stronger incentivesgreater rewards-as compared with nonprofit hospitals, for performance that is more easily monitored. While our findings are consistent with more than one model of comparative organization behavior, they are consistent with a model in which nonprofit and for-profit organizations differ in their goals and, hence, in the kinds of managers they demand and the reward structures they offer. Nonprofit organizations may pursue objectives that reflect greater concern about collective goods or other outputs that are more difficult to measure and reward. Alternatively, nonprofits, confronted by a nondistribution constraint on the payout of profit to managers, may lack incentives for efficiency, and so may pursue other goals such as a quiet life. Such differential objective functions, together with the dif
199 citations
••
TL;DR: This paper examined the impact of organizational founding conditions on several facets of bureaucratization, including managerial intensity, the proliferation of specialized managerial and administrative roles, and formalization of employment relations.
Abstract: Excerpt] This article examines the impact of organizational founding conditions on several facets of bureaucratization—managerial intensity, the proliferation of specialized managerial and administrative roles, and formalization of employment relations. Analyzing information on a sample of technology start-ups in California's Silicon Valley, we characterize the organizational models or blueprints espoused by founders in creating new enterprises. We find that those models and the social composition of the labor force at the time of founding had enduring effects on growth in managerial intensity (i.e., reliance on managerial and administrative specialists) over time. Our analyses thus provide compelling evidence of path dependence in the evolution of bureaucracy—even in a context in which firms face intense selection pressures—and underscore the importance of the "logics of organizing" that founders bring to new enterprises. We find less evidence that founding models exert persistent effects on the formalization of employment relations or on the proliferation of specialized senior management titles. Rather, consistent with neo-institutional perspectives on organizations, those superficial facets of bureaucracy appear to be shaped by the need to satisfy external gatekeepers (venture capitalists and the constituents of public corporations), as well as by exigencies of organizational scale, growth, and aging. We discuss some implications of these results for efforts to understand the varieties, determinants, and consequences of bureaucracy.
174 citations
••
TL;DR: In this paper, the authors test the major implications of a principal-agent model of contracts using detailed data on more than 4,000 individual contracts from modern North American agriculture and find some support for models that assume risk-neutral contracting parties and stress multiple margins for moral hazard and enforcement costs.
Abstract: Structuring contracts to share risk in light of incentive problems is the central premise of contract theory, yet the risk-sharing implications have rarely been thoroughly tested using micro-level contract data. In this article we test the major implications of a principal-agent model of contracts using detailed data on more than 4,000 individual contracts from modern North American agriculture. On a case-by-case basis, our evidence fails to support the standard principal-agent model with risk aversion as an explanation of contract choice in modern North American farming. At the same time, we find some support for models that assume risk-neutral contracting parties and stress multiple margins for moral hazard and enforcement costs. Copyright 1999 by Oxford University Press.
171 citations
••
TL;DR: The U.S. Supreme Court is one institution where sophisticated voting should be common, but, paradoxically, where scholarly consensus about its existence has yet to emerge as mentioned in this paper, and sophisticated voting has raised serious questions about its empirical importance in real-world institutions.
Abstract: "Sophisticated voting" has a solid theoretical foundation, but scholars have raised serious questions about its empirical importance in real-world institutions. The U.S. Supreme Court is one institution where sophisticated voting should be common, but, paradoxically, where scholarly consensus about its existence has yet to emerge. We develop and test a formal model of sophisticated voting on agenda setting in the Supreme Court. Using data on petitions for certiorari decided in October term 1982, we show that, above and beyond the usual forces in case selection, justices engage in sophisticated voting, defined as looking forward to the decision on the merits and acting with that potential outcome in mind, and do so in a wide range of circumstances. In particular, we present strong evidence for sophisticated behavior, ranging from votes to deny a case one prefers to reverse to votes to grant cases one prefers to affirm. More importantly, sophisticated voting makes a substantial difference in the size and content of the Court's plenary agenda. Copyright 1999 by Oxford University Press.
170 citations
••
TL;DR: In this paper, the authors describe optimal bankruptcy laws in a framework with asymmetric information, and reinterpret much of the evidence on the performance of Chapter 11, the "rather soft" U.S. reorganization procedure, questioning many negative conclusions.
Abstract: This article describes optimal bankruptcy laws in a framework with asymmetric information. The key idea is that the financial distress of a firm is not observed by its lenders for quite a while. As early rescues are much cheaper than late rescues, it may pay if the creditors are forgiving in bankruptcy, thereby inducing the revelation of difficulties as early as possible. Either “tough” or “soft” bankruptcy laws can be optimal, depending on the parameters. This implies that mandatory one-size-fits-all bankruptcy procedures cannot be optimal. “Hybrid” procedures, which try to combine elements of soft and tough procedures, are found to be redundant, and possibly harmful. Absolute priority rules may be helpful as a part of tough procedures, but their introduction is (partly) inconsistent with the design of soft procedures. The article also reinterprets much of the evidence on the performance of Chapter 11, the “rather soft” U.S. reorganization procedure, questioning many negative conclusions.
••
TL;DR: In this article, the authors developed a theory of business networks where they are endogenous to the reliability of the legal system and found that networks are economically inefficient unless they are relatively large.
Abstract: Business networks are a feature of the organizational landscape of many countries, though they vary in magnitude. This article develops a theory of business networks where they are endogenous to the reliability of the legal system. Networks are a substitute for reliable institutional support that guarantees written contracts. The existence of networks exerts a negative effect on the functioning of the anonymous market. This is because the network absorbs honest individuals, raising the density of dishonest individuals engaged in anonymous market exchange. Since this lowers the payoff from market exchange, larger networks may be easier to enforce. We find that networks are economically inefficient unless they are relatively large. This is consistent with the view that informal contract enforcement institutions may be inefficient in general equilibrium even though they enhance efficiency in partial equilibrium.
••
TL;DR: Li et al. as mentioned in this paper found that performance contracts (PCs) did not improve performance and may have made it worse, and that PC effects were on average negative because of the large losses associated with poorly designed PCs.
Abstract: Performance contracts (PCs)--contracts signed between the government and state enterprise managers--have been used widely in developing countries. China's experience with such contracts was one of the largest experiments with contracting in the public sector, affecting hundreds of thousands of state firms, and offered a rare opportunity to explore how PCs work. On average, PCs did not improve performance and may have made it worse. But China's PCs were not uniformly bad; in fact, PCs improved productivity in slightly more than half of the participants. PC effects were on average negative because of the large losses associated with poorly designed PCs. Successful PCs were those that featured sensible targets, stronger incentives, longer terms, managerial bonds, and were in more competitive industries. Selecting managers through bidding was not associated with performance improvement. Good PC features were more often observed in state-owned enterprises (SOEs) under the oversight of local governments, that faced more competition, that were smaller in size, and that had better previous performance. Copyright 2001 by Oxford University Press.
••
••
TL;DR: In this paper, the authors present models of strategic behavior by agencies and courts where the ability to manipulate the instruments of decision making, rather than merely selecting policy choices, allows actors to insulate their policy choices from higher level review.
Abstract: This article presents models of strategic behavior by agencies and courts where the ability to manipulate the instruments of decision making, rather than merely selecting policy choices, allows actors to insulate their policy choices from higher level review. The theory is based on the notion that decision instruments (for example, rulemaking and adjudication for agencies, statutory interpretation and reasoning process review for courts) pose differential costs and payoffs for both the initiating and reviewing actors, each of whom have resource constraints. Because the initiating actor has the choice among instruments to make a decision (and to which a higher level reviewing actor is tied), the initiating actor can manipulate decision costs in a strategic fashion (choosing high-cost instruments to discourage higher level review, in particular). This article adds new insight into how judges and agencies engage in strategic decision making.
••
TL;DR: In this paper, the authors analyze the incentives and outcomes that different procedural and therefore interest group environments generate, and find that a politician is better off with a biased group monitoring the agency rather than a neutral one, since biased groups will subsidize a portion of monitoring cost.
Abstract: A number of scholars have identified the important role administrative procedures have in 'structuring' the interest group environment of government agencies: determining who can participate and in what manner. Using a formal model, we analyze the incentives and outcomes that different procedural--and therefore interest group--environments generate. The model yields a number of important conclusions. First, because elected officials are concerned not only about distributional rents, but also informational ones, the use of procedures in some cases will result in worse outcomes for political principals on the policy dimension. Officials will be willing to bear the losses in exchange for informational gains. Second, under certain conditions, a politician is better off with a biased group monitoring the agency rather than a neutral one, since biased groups will subsidize a portion of the monitoring cost. Third, having multiple interest groups, including one in opposition to the politician, makes the political principal strictly better off than any other constellation of monitors, since competing interest groups will provide the greatest information at the lowest cost to the elected official. Copyright 1999 by Oxford University Press.
••
TL;DR: In this paper, the authors study the effects of allowing value diversion on managerial compensation and effort, and show that even if the consequences of a rule permitting value diversion can be fully taken into account in setting managerial compensation, such a rule might still produce a reduction in shareholder wealth.
Abstract: The agents to whom shareholders delegate the management of corporate affairs may transfer value from shareholders to themselves through a variety of mechanisms, such as self-dealing, insider trading, and taking of corporate opportunities. A common view in the law and economics literature is that such value diversion does not ultimately produce a reduction in shareholder wealth, since value diversion simply substitutes for alternative forms of compensation that would otherwise be paid to managers. We question this view within its own analytical framework by studying, in a principal-agent model, the effects of allowing value diversion on managerial compensation and effort. We suggest that the standard law and economics view of diversion overlooks a significant cost of such behavior. Many common modes of compensation can provide managers with incentives to enhance shareholder value; replacing such compensation would reduce these incentives. As a result, even if the consequences of a rule permitting value diversion can be fully taken into account in setting managerial compensation, such a rule might still produce a reduction in shareholder wealth—and would not do so only if value diversion would have some countervailing positive effects (a possibility which our model considers) that are sufficiently significant in size.
••
TL;DR: In this article, a scheme of selective audits is proposed to restore stronger incentives for the appraisal of less tangible activities by observing high performance levels in the more visible tasks, which is optimal under plausible assumptions concerning the monitoring technology (separability of the multivariate likelihood function) and the agent's risk behavior.
Abstract: In multiple-task agency setups it is commonly accepted that wage incentives must be weaker when the agent's performance on some of the activities is difficult to measure. This article shows that stronger incentives can be restored through a scheme of selective audits in which the appraisal of less tangible activities is contingent on observing high performance levels in the more visible tasks. This scheme would make the efforts expended on the various tasks complementary rather than substitutes in the agent's utility function. It is optimal under plausible assumptions concerning the monitoring technology (separability of the multivariate likelihood function) and the agent's risk behavior (absolute prudence larger than three times absolute risk aversion). Then Etienne began to read him the announcement. It was a notice from the Company to the miners of all the pits, informing them that in consequence of the lack of care bestowed on the timbering, the Company had resolved to apply a new method of payment for the extraction of coal. Henceforward the price of the tub of coal extracted would be lowered, from fifty centimes to forty, and the Company itself would pay for the timber.
••
TL;DR: In this article, the authors extend the existing theory and empirical investigation of unitization contracts and measure the industry's actual behavior against the principles of production from a common pool, highlighting the importance of incentive-compatibility and self-enforcement and the bargaining problems faced in achieving viable, longterm contracts.
Abstract: This article extends the existing theory and empirical investigation of unitization contracts. It highlights the importance of incentive-compatibility and self-enforcement and the bargaining problems faced in achieving viable, long-term contracts. We argue that only if the parties to a unitization contract have unit production shares that are the same as their cost shares will the contract be incentive compatible. Using a database of 60 unit operating agreements, we measure the industry’s actual behavior against the principles of production from a common pool. Our survey of units that have only one production phase and that are relatively homogeneous reveals that such equal sharing rules are always found and they appear to encourage the parties to behave optimally. In more complex units with multiple production phases and=or separate concentrations of oil and gas (gas caps) we find deviations from the theoretical ideal. In the case of multiphase units, we find equal cost and production shares within phases, but not across phases. A preset trigger for shifting from one production phase to the next helps to maintain optimal behavior. For gas cap units, however, we generally do not find the equal sharing rule. Conflicts and rent dissipation follow as illustrated by the case of the Prudhoe Bay Unit. The article describes the desirable contract rules for avoiding moral hazard. It also shows how the effects of those rules can be replicated in difficult situations.
••
TL;DR: In this paper, it was shown that it is profitable to employ a supervisor when information is "soft" even though the three parties can collude, and that standard applications of the PCA model to regulation and auditing have more scope than previously thought.
Abstract: In the standard principal-supervisor-agent model with collusion, Tirole (1986) shows that employing a supervisor is profitable for the principal if the supervisor's signal of the agent's cost of production is 'hard' (i.e., verifiable but hideable). Anecdotal evidence suggests that information is sometimes 'soft' (i.e., unverifiable). We show that, in fact, it is profitable to employ a supervisor when information is 'soft' even though the three parties can collude. Therefore, standard applications of the principal-supervisor-agent model to regulation and auditing have more scope than previously thought. Copyright 1999 by Oxford University Press.
••
TL;DR: The authors identify a class of situations where single individuals or parties may use the freedom to contract to subtly manipulate large groups of individuals by offering them contracts that promote free-riding behavior.
Abstract: We present an economic argument for restraining certain voluntary agreements. We identify a class of situations where single individuals or parties may use the freedom to contract to subtly manipulate large groups of individuals by offering them contracts that promote free-riding behavior. We provide three examples where placing restrictions on the freedom to contract may prove beneficial. The first example provides a rationale for the prohibition of exclusionary contracts. We point to the role most favored nation clauses may play in facilitating such inefficient exclusionary practices. The second example provides justification for prohibiting employers from proposing to compensate workers for committing not to join a labor union. The third example provides a rationale for the ban against vote trading.
••
TL;DR: In this paper, the authors analyze how bureaucracies are erected within the firm to control information flows and protect clients, and show that employees may leak and otherwise abuse information to enhance their personal performance and wealth.
Abstract: Firm organization determines how coworkers communicate and how information flows within the firm. Banking, accounting, consulting, and legal firms process proprietary information which their clients wish to protect. The firm's ability to safeguard and manage information determines its market demand. Yet employees may leak and otherwise abuse information to enhance their personal performance and wealth. This article analyzes how bureaucracies are erected within the firm to control information flows and protect clients. Copyright 1999 by Oxford University Press.
••
TL;DR: In this article, the authors empirically examined the impact of congressional oversight and agency rulemaking on firm compliance behavior in FDA-regulated industries and found that congressional oversight deters industry noncompliance.
Abstract: This article empirically examines the impact of congressional oversight and agency rulemaking on firm compliance behavior in FDA-regulated industries. Congressional oversight hearings provide signals to firms about future changes in regulatory enforcement strategies. Agency rulemaking influences firms' incentives to comply with regulation because firms must invest significant resources to keep up with changing agency policy. This analysis uses three-stage least squares to simultaneously estimate both the numbers of FDA inspections and industry violators between 1972 and 1994. Results show that congressional oversight deters industry noncompliance. The effect of agency rulemaking on noncompliance differs between industries. For instance, an increasing stock of human drug rules has raised compliance among drug firms because newer more, cost-effective rules have replaced older, more costly rules. In contrast, the increasing stock of medical device rules has reduced industry compliance among device firms because these rules have increased the complexity and the scope of regulation. Copyright 1999 by Oxford University Press.
••
TL;DR: In this paper, the authors show that the ability of insolvent firms to continue bad projects is enhanced by the absence of ipso facto clauses without such a clause, the firm can exploit the inability of courts always to assess expectation damages accurately to compel a solvent party to stay in a bad deal.
Abstract: Section 365 of the Bankruptcy Code prohibits enforcement of the once common “ipso facto clause” The clause excuses the solvent party from performance of the contract when the other party becomes insolvent We show that the ability of insolvent firms to continue bad projects is enhanced by the absence of ipso facto clauses Without such a clause, the firm can exploit the inability of courts always to assess expectation damages accurately to compel a solvent party to stay in a bad deal An ipso facto clause would preclude this outcome because the clause permits the solvent party to exit costlessly Further, an ipso facto clause improves the managers’ incentive to exert effort to avoid financial distress These results have two broader implications First, that the important mandatory rule regulating the ability of solvent parties to exit is inefficient suggests that the justifications for the Bankruptcy Code’s other mandatory rules should be rethought Second, our analysis suggests that stakeholders such as contract partners of bankrupt firms may have important roles to play in inducing efficient bankruptcy decisions through their abilities to stop unproductive projects that bankrupt firms may otherwise continue
••
TL;DR: In this paper, the authors argue that the focus on physical asset ownership is a defining feature of a firm and that asset ownership conveys control rights (in particular, the ability to set incentives); and the metaphor of the firm as an island economy.
Abstract: But like Shakespeare's Mark Anthony, my role as commentator is "not to praise Caeser." And while I wouldn't go so far as to claim it's to bury him, there are nonetheless aspects of this article that warrant challenge. Three related aspects of the article are especially problematic: first, the focus on physical asset ownership as being a defining feature of a firm; second, the claim that asset ownership conveys control rights (in particular, the ability to set incentives); and, third, the metaphor of the firm as an "island" economy. It is not that I think Professor Holmstrom is wrong (except, arguably, about the metaphor), but rather that I think he has misplaced, at times, his emphasis. Secondary effects, in places, seem to be primary and at least one primary effect seems to have got lost in the shuffle. An example may help the reader appreciate the perspective I will take in this commentary. My recollection from high-school American history is that the militias that fought the British in the American Revolution were entirely voluntary organizations. Their principal assets, muskets and uniforms, were generally supplied by the militia men themselves. Moreover, they elected their own officers. After election, the officers made the decisions and the rest of the militia were expected to execute the resulting orders, with the militia enjoying some ability to punish those who disobeyed orders. Admittedly, a militia is not a firm, but it shares certain commonalities with a firm and it is worth, therefore, "explaining" its organizational design. Although these militias used physical assets, asset ownership was not critical to their organizational design. Certainly asset ownership was not relevant to
••
TL;DR: In this article, the importance of transaction-specific investments in determining contract choice in the intermediate market for raw fish was tested using information from a large sample of implicit contracts between fishers and processors in British Columbia for the 1988 fishing season.
Abstract: This article tests the importance of transaction-specific investments in determining contract choice in the intermediate market for raw fish. The analysis uses information from a large sample of (implicit) contracts between fishers and processors in British Columbia for the 1988 fishing season. These contracts are of two general types: spot-market arrangements, and ex ante agreements. With a spot contract, buyers and sellers of fish seek one another after incurring seasonal investments (e.g., vessel maintenance, crew, processing facilities, etc.); there is no prior agreement for exchange, nor is there an agreement the relationship will continue beyond the transaction.' With ex ante agreements, the parties agree to trade with one another, perhaps exclusively, prior to either party incurring seasonal start-up costs. These agreements typically have nonprice compensation mechanisms such as financing of vessels by processors, and
••
TL;DR: In this article, a decision-maker's limited attention is allocated between writing new contracts and directing current contracts, and the optimal allocation of attention implies two types of contracts, relational and market.
Abstract: A decision-maker's limited attention is allocated between writing new contracts and directing current contracts. More time spent writing a new contract makes the contract more complete. A more complete contract performs better and generates higher returns. The optimal allocation of attention implies two types of contracts, relational and market. A relational contract, which is directed periodically, is optimally less complete than a market contract, which is not directed. The completeness of relational contracts decreases with the ability to direct contracts, since changing circumstances can be dealt with later. In addition, the completeness of relational contracts increases with the ability to write new contracts, since more complete relational contracts are directed less frequently and leave more time for writing new contracts. The optimal allocation of attention to relational contracts is socially efficient even though it does not maximize the discounted expected returns of the firm.
••
TL;DR: In this article, a model of the policy decision process in ministerial governments is presented, where a spending minister and a finance minister are involved in making a decision concerning a public project.
Abstract: This article analyzes a model of the policy decision process in ministerial governments. A spending minister and a finance minister are involved in making a decision concerning a public project. The two ministers have partially conflicting preferences. Policy decisions are made in two stages. In the first stage the spending minister consults a technical expert to obtain information about the technical consequences of the project. If the technical consequences are favourable, in the second stage the finance minister consults a financial expert to obtain information about the financial consequences. The finance minister can veto a proposal for undertaking the project. This article illustrates the consequences of specialization for information transmission. A drawback of specialization is that projects are evaluated on the basis of their individual consequences rather than on the basis of their total consequences.
••
TL;DR: This article found that test bias against a group is consistent with the test overpredicting group members' performance, and that an affirmative action program may be needed to achieve color-neutral results.
Abstract: Employers or universities determine the qualifications of applicants based on the results of a test. Members of socioeconomically disadvantaged groups tend to score less well than equally qualified members of other groups. As a result, color blind practices discriminate against disadvantaged groups. This discrimination may persist even if rational firms realize that the test is (statistically) biased. Furthermore, test bias against a group is consistent with the test overpredicting group members' performance. An affirmative action program may be needed to achieve color-neutral results. Copyright 1999 by Oxford University Press.
••
TL;DR: La Porta, Lopez-de-Silanes, Shleifer, and Vishny as discussed by the authors argue that there are particular political, cultural, and economic reasons why some government institutions are better in the sense that they produce better economic returns for the population, why would they not be generally adopted?
Abstract: The questions asked by La Porta, Lopez-de-Silanes, Shleifer, and Vishny are very important and inherently interesting. In general terms, if some (government) institutions are better in the sense that they produce better economic returns for the population, why would they not be generally adopted? The authors argue that there are particular political, cultural, and economic reasons, and they argue that these reasons are both conceptually and empirically distinct. Their measures of political and cultural variables have deep historical roots, suggesting major long-run differences in how a whole social system operates. Indeed, their model is at the level of Weber's (1958) Protestant ethic: Very general political and cultural attributes of a country, certainly not obviously related to any aspects of a country's output, impact governmental performance. The test they construct is a cross section of a large number of countries. While the argument is causal, the test is not. Though the characteristics they select are historically prior to their measures of particular aspects of government, neither the historic development of individual governments nor the causal mechanisms through which particular governmental structures and institutions were created are theorized or modeled. The inefficiency of socialist political systems are well documented, but the degrees of efficiency associated with other kinds of legal systems are not and it is not clear what results should be expected. To the degree that French legal origin is correlated with its former African colonies (e.g., Algeria), the Middle East, and southern Europe and related colonial influence within South America, the correlation with low government performance is not entirely surprising. Religious background and ethnolinguistic fractionalization are even less clear; countries differ in the degree to which these factors are allowed to enter into the governmental arena, and indeed the relevant question about ethnolinguistic fractionalization might well be under what conditions does it persist or assimilation take place? Theory and measures developed in some of the relevant literature they cite in the article might help to bridge the causal gap between governmental institutions and the very general concepts of legal system, religion, and ethnolinguistic differentiation that they rely upon. Recognizing the difficulty of putting these