ProfessorBainbridge.com

Coase in Action

T odd Zywicki defends the do-not-call registry from attacks by libertarians and small-government conservatives:

I believe the criticism is misplaced--the DNC registry is simply law & economics in action. It took an ambiguously defined property right (when can telemarketers call you), defined it clearly (telemarketers can call you whenever they want to), and provided a low-cost way of reallocating the property right (register on the DNC). Thus, it is nothing more than the Coase Theorem in action.

But even more, the DNC is actually the first example I can think of that illustrates a Contracts principle of an efficient minoritarian default rule. Usually contract default rules are allocated so as to create a majoritarian default rule (i.e., what the majority of people would want). Based on the registration numbers, a majority of Americans want to be free from telemarketing calls. So why not make the default rule "no calls" and make the telemarketers get your permission? Leaving aside the logistical problems (Would calling you to ask you if you want to be called count as a telemarketing call?), the minoritarian default rule is efficient because the transaction costs of reallocating are so munch lower for consumers than for telemarketers, especially because the FTC made registration so easy.

If you're wondering what the Coase theorem is, go here.

The SEC: From Bad to Worse?

My latest TCS Daily column

In October of last year, the SEC proposed a new rule that would permit shareholders to directly nominate directors of the corporations in which they have invested. As I detailed in my TCS column, Does the SEC Know When Enough Is Enough?, the proposal was seriously flawed. It was likely to impose significant indirect costs on corporations, without much in the way of countervailing benefits. (For more details, see my blog's archive of posts on the rule.)

As bad as the original proposal was, however, things may be about to take a turn for the worse.

The WSJ ($) reports that a "compromise" is in the works, under which:

"While details of the proposal are still being worked out, it would essentially allow shareholders to sit down with a company and agree on a person to replace a director who has been targeted by investors for removal. If an agreement couldn't be reached, shareholders would likely gain the right to nominate their own director the following year. The proposal may allow companies to bypass negotiating with investors if they agree to include shareholder-backed nominees on the ballot the following year."

Problems:

(1) Which shareholders get to sit down with management? All of them, which can be in the millions, or just a select few? If a select few, how do we ensure that the interests of the few coincide with those of the many? How, for example, do we ensure that unions don't use the shareholder access rule for leverage in collective bargaining (as they often use the current shareholder proposal rule)? Or that social activists don't use it to promote a social agenda at odds with the profit-maximization interests of most shareholders?

(2) If adopted, the proposal may deter qualified individuals from being willing to serve as a member of the board. There will be a significant risk that activist investors will use the rule frequently and at numerous companies. Unlike the current system, under the rule, the activists will be targeting individual investors. Who would want to serve as a director if there is a significant risk one might be singled out for a smear campaign by unhappy investors? (Granted, the effect may only be at the margins, but many companies report that in light of the director liabilities created by Sarbanes-Oxley they are already having a hard time attracting independent directors.)

(3) The presence on the board of a single shareholder-approved director likely will have a highly disruptive effect on the board's decisionmaking processes. Granted, some firms might benefit from the presence of skeptical outsider viewpoints. The analogy to cumulative voting, however, suggests that such benefits will be rare. It is well-accepted that cumulative voting tends to promote adversarial relations between the majority and the minority representative. On such boards, the majority tends to resort to pre-meeting caucuses at which decisions are worked out. In addition, management tends to restrict the flow of information to such boards, out of concern that the minority will use confidential firm information for improper purposes. A chief indirect cost of the proposed compromise therefore will be less effective governance.

(4) Finally, and perhaps most disturbingly, there is still nothing in the reported compromise that would limit the rule to situations in which the targeted board is clearly dysfunctional. Instead, it apparently still applies to all public corporations, whether their internal governance is good, bad, or just indifferent. Hence, if enough shareholders are disgruntled, for whatever reason, they can force a vote. This makes no sense. The point of the rule, supposedly, is to restore investor confidence by ensuring good corporate governance. But if firms are well-managed why put them to the expense and bother of a shareholder nomination contest?

Several recent major SEC rules were adopted by a 3-2 vote, with SEC Chairman Donaldson (a Republican) siding with the Commission's two Democrats against his two fellow Republicans. It's been reported that Chairman Donaldson doesn't want to see that happen to this particularly controversial rule. Potential dissenters Glassman and Atkins thus may have significant leverage. If they can't use it to kill the proposal, they should use at the very least use it to emasculate the rule so that it does as little damage to corporate governance as possible.

Chateau Montelena Estate Zinfandel (Napa Valley) 2000

A yummy Zinfandel that is in prime drinking age. Great nose of cherries, berries, leather, and tar. The palate offers black cherries, berries, minerals, and earth. A slight touch of dill suggests American oak. Grade: B+

Corporations Reading Blogs

The Guardian reports that corporations are starting to notice how blogs affect their brands:

The sites that started as observational home pages for enthusiasts have become so powerful that they are starting a new industry of blog monitoring in which media companies scour the net to advise brands on how their name is being talked about online, away from the traditional newspaper and broadcast media sites.

Olympus, for example, has devised a new marketing strategy to embrace the medium. Whenever a new camera is approaching its launch, details are passed on to prominent blogs, a spokesman reveals, because the sites are crucial to getting interest ahead of the launch as well as getting early feedback on what the public thinks of the new model. [N.B.: I wish I could get some wineries doing that for me!] ...

The classic case of what can happen if you do not tune in to the blogger came with a flood of bad publicity for Maytag, a top-end washing machine manufacturer in America. Complaints about one of its models not emptying properly, and so smelling out kitchens, had been appearing on many blogs until they finally hit the site of Bob Vila, presenter of a popular property show called This Old House. It resulted in national press coverage of a problem that Clare Hart, CEO of media monitoring agency Factiva, believes could have been nipped in the bud, had the company been alert to the power of the blog.

Shareholder Democracy

My colleagues Lynn Stout and Iman Anabtawi have an op-ed in today's WSJ (subcriber link; nonsubscriber link) on shareholder democracy and the SEC's pending shareholder access rule:

American corporate law gives entrepreneurs seeking to sell stock in the companies they create the freedom to draft their corporate charters almost any way they like. This includes freedom to draft charters that either enhance shareholder voting power, or dilute it. If investors valued strong voting rights, you'd think they would pay more for the shares of companies that granted them. Corporate entrepreneurs would respond by supplying charters that give shareholders greater clout.

Yet in the real world, companies almost never "go public" with enhanced shareholder power. Instead, most IPO charters weaken shareholders' rights. Google is a case in point. Its charter gives its founders shares with multiple votes while the public gets shares with only a single vote. Such "dual class" stock is unusual, but milder forms of shareholder disenfranchisement abound. Most IPO charters these days include "staggered board" provisions making it harder for shareholders to replace incumbent directors. Far from avoiding these IPOs, investors, including sophisticated institutions, snap them up like hotcakes.

... Why, if greater power is such a boon to investors, haven't they already demanded it? Maybe because greater shareholder power isn't so wonderful for investors after all. This argument is being advanced by Google's founders, and it enjoys support from many corporate scholars as well. ...

First, even finance economists increasingly acknowledge what businesspeople have always known: stock prices don't always accurately measure value. (Remember the Internet bubble?) As a result boards can often do a far better job of picking the business strategy best for the firm in the long run than unorganized, uninvolved, and price-obsessed stockholders can.

Second, investors don't always share common interests. The SEC's proposed rule would allow only shareholders with large holdings to push their own board candidates. This invites intra-shareholder conflict, allowing large investors-including financial intermediaries, union-sponsored pension plans, and politically-motivated groups-to nominate directors who will represent only their own special interests.

Third, strong boards can mediate not only conflicts among shareholders, but also conflicts between shareholders and other important corporate constituencies. The "team production" theory of corporate governance teaches that a principal function of board governance is to encourage executives, customers, rank-and-file employees, and others to make long-term commitments to a company by assuring these groups corporate policy will not be set by an anonymous, myopic, return-hungry pack of shareholders. Shareholders go along because, by ceding control to boards, they get greater loyalty and commitment from others. Google's investors may well believe the firm's founders and employees will work harder and better with a dual-class structure that protects them against hostile takeovers or shareholder pressures to raise profits by outsourcing jobs and cutting employee benefits.

Personally, I find only their second argument persuasive. (See my TCS column Does the SEC Know When Enough Is Enough?.) As for reason # 1, I agree that boards have better information than shareholders. But the existence of such an information asymmetry is independent of whether markets accurately price stock. As to the latter question, I still believe in the efficient capital markets hypothesis as the best available theory of how markets behave. As for reason # 3, I remain unpersuaded by my friend and colleague Lynn Stout's team production model of corporation law. Unfortunately, my critique of that model is way too long for a blog post, but you can download the law review article in which I rejected the team production model.

Generals Should be Seen and not Heard

Many folks in the blogosphere are impressed by retired General Tommy Franks' recent political commentary (e.g., Tung Yin calls it "fair and balanced"). I'm not. Instead, I agree with Eliot Cohen's WSJ op-ed from a few weeks ago:

The Kerry campaign has announced its list of retired generals and admirals endorsing their candidate; the Bush campaign will soon produce its list, and no doubt both will mobilize more retired stars for the coming fight. One need not be paranoid about civil- military relations to think this a bad business, reckless on the part of the politicians and destructive on the part of the former flags. By serving as props for presidential candidates the retired generals put at risk the confidence that citizens and officials alike place in the political neutrality of the armed forces. They have every legal and constitutional right to behave this way, of course, as they have every right to make second careers as pole dancers in Vegas. But in so doing they diminish American politics, and damage the national defense. ...

In a way, then, generals never retire. When they become openly political, endorsing one candidate or denouncing another, they create the notion that the military is a constituency -- the unfortunate word reportedly used by the late Secretary of Defense Les Aspin -- rather than a neutral instrument of policy. In 2000, there was far too much suspicion on one side, and glee on the other, at the likely impact of military votes on the outcome of the election. If the public becomes accustomed to thinking of the military as the uniformed equivalent of the National Education Association, it will be treated as such by politicians -- romanced or paid off, marginalized or denounced as circumstances suggest.

The endorsing generals have an effect on the troops. The captains and sergeants get the impression that although more discretion is allowed retirees than active-duty soldiers, there's nothing wrong with a military person articulating partisan views. And from there the leap is not so long to obstructing policies with which one disagrees, while the distance lengthens to becoming a professional who can be relied upon to give objective advice on sensitive matters. ...

The politicians will woo the flags: In the contest for office, most scruples mean little. As in so many other cases, the burden falls upon the retired generals themselves to hold the line, to adhere to standards of professional conduct that civilians may not even understand. The vast majority of the retired flag officers remain discreetly silent during political campaigns, because they know that partisanship does no good to the armed services or the country. The U.S. has more than enough real battles for the military to fight, and the political neutrality and discretion of our generals is too valuable at any time -- but during wartime above all -- to jeopardize for passing partisan advantage.

I'd admire Tommy Franks a lot more if he had kept his mouth shut.

Kerry Defies His Church ... Again

Kerry promises to lift ban on stem cell reasearch:

Kerry said in the Democrats' weekly radio address: "Here in America we don't sacrifice science for ideology. We are a land of discovery, a place where innovators and optimists are free to dream and explore."

So now he's reduced faith and religious values, including the teachings of his own church, to "ideology." Sigh. Just for the record, here's a collection of links on what his Church teaches on stem cell research. A useful summary of Church teaching is provided by the Pontifical Academy for Life's Declaration on stem cell research, which asserts:

The first ethical problem, which is fundamental, can be formulated thus: Is it morally licit to produce and/or use living human embryos for the preparation of ES cells?

The answer is negative, for the following reasons:

1. On the basis of a complete biological analysis, the living human embryo is - from the moment of the union of the gametes - a human subject with a well defined identity, which from that point begins its own coordinated, continuous and gradual development, such that at no later stage can it be considered as a simple mass of cells.

2. From this it follows that as a Ahuman individual" it has the right to its own life; and therefore every intervention which is not in favour of the embryo is an act which violates that right. Moral theology has always taught that in the case of Ajus certum tertii" the system of probabilism does not apply.

3. Therefore, the ablation of the inner cell mass (ICM) of the blastocyst, which critically and irremediably damages the human embryo, curtailing its development, is a gravely immoral act and consequently is gravely illicit.

4. No end believed to be good, such as the use of stem cells for the preparation of other differentiated cells to be used in what look to be promising therapeutic procedures, can justify an intervention of this kind. A good end does not make right an action which in itself is wrong.

5. For Catholics, this position is explicitly confirmed by the Magisterium of the Church which, in the Encyclical Evangelium Vitae, with reference to the Instruction Donum Vitae of the Congregation for the Doctrine of the Faith, affirms: AThe Church has always taught and continues to teach that the result of human procreation, from the first moment of its existence, must be guaranteed that unconditional respect which is morally due to the human being in his or her totality and unity in body and spirit: >The human being is to be respected and treated as a person from the moment of conception; and therefore from that same moment his rights as a person must be recognized, among which in the first place is the inviolable right of every innocent human being to life.'"

The second ethical problem can be formulated thus: Is it morally licit to engage in so-called Atherapeutic cloning" by producing cloned human embryos and then destroying them in order to produce ES cells?

The answer is negative, for the following reason: Every type of therapeutic cloning, which implies producing human embryos and then destroying them in order to obtain stem cells, is illicit; for there is present the ethical problem examined above, which can only be answered in the negative.

The third ethical problem can be formulated thus: Is it morally licit to use ES cells, and the differentiated cells obtained from them, which are supplied by other researchers or are commercially obtainable?

The answer is negative, since: prescinding from the participation - formal or otherwise - in the morally illicit intention of the principal agent, the case in question entails a proximate material cooperation in the production and manipulation of human embryos on the part of those producing or supplying them.

In conclusion, it is not hard to see the seriousness and gravity of the ethical problem posed by the desire to extend to the field of human research the production and/or use of human embryos, even from an humanitarian perspective.

Unfortunately, it seems our society has become so narssistic that we will encourage the mass murder of thousands (millions?) of human embryos in pursuit of relatively modest hopes for self-benefit.

Counting College

Pejman Yousefzadeh has an interesting speculative analysis of how the Electoral College is shaping up.

Director independence

I just ran across a very interesting paper by a couple of Swedish economists, Board Independence and Product Market Competition in Swedish Firms, in which they conclude:

This study suggests that firms in highly competitive industries should have fewer outside board members, whereas companies operating in less competitive industries should have more outside directors. Specifically, we argue that board independence is less relevant or even redundant in highly competitive industries, where the firm is already monitored by a competitive product market. Using publicly traded Swedish firms for empirical testing, this study finds that board independence reduces firm performance in industries with highly competitive product markets. On the other hand, board independence enhances firm performance among companies facing less competitive product markets.

I don't know enough about the Swedish economy to predict with complete confidence that the same result would hold in the US, but it wouldn't surprise me a bit. Independent directors are not the sole mechanism by which management?s performance is monitored. Rather, a variety of forces work together to constrain management?s incentive to shirk: the capital and product markets within which the firm functions; the internal and external markets for managerial services; the market for corporate control; incentive compensation systems; auditing by outside accountants; and many others. The importance of the independent directors? monitoring role in a given firm depends in large measure on the extent to which these other forces are allowed to function. For example, managers of a firm with strong takeover defenses are less subject to the constraining influence of the market for corporate control than are those of a firm with no takeover defenses. The former needs a strong independent board more than the latter does. Hence, I'm inclined to file this one away as another data point supporting my view that government-mandated one-size-fits-all rules requiring firms to have specific numbers of independent directors and to put them in specific roles are bad public policy. (See, e.g., A Critique of the NYSE's Director Independence Listing Standards.)

Smith-Madrone Chardonnay (Napa Valley) 1999

Regular readers of my wine notes know that Smith-Madrone is one of my favorite boutique Napa wineries. They produce excellent wines at very fair prices. Although the wines are neither cheap nor inexpensive, they offer excellent value for wines of such exceptional quality. I picked up this 99 Chardonnay at the winery when I was in Napa last May. Unlike most California chards, which are falling apart at age 3, this wine was still going strong at age 5. I suspect it would have continued to improve for several more years. The wine is driven more by its fruit than oak, although there is a pleasing undertone of buttery oak flavors. I get pineapples and bananas on both the nose and palate. A very nice note of ripe apple also shows on the finish. If you can find it, buy it (try the winery). The dominance of the fruit over oak makes this an especially useful wine with food, whereas so many California chards really don't play well with dinner. It would go great with cracked crab, for example. Grade: A-

Work, work, work .... except in Europe

Historian Niall Ferguson ably summarizes the familiar data on how much less Europeans work than Americans and then offers a very provocative explanation:

I cannot resist suggesting another possible explanation - one that owes a debt to Weber's famous essay The Protestant Work Ethic and the Spirit of Capitalism, which he wrote almost exactly a century ago.

Weber believed he had identified a link between the rise of Protestantism and the development of what he called "the spirit of capitalism". I would like to propose a modern version of Weber's theory, namely "The Atheist Sloth Ethic and the Spirit of Collectivism".

The most remarkable thing about the transatlantic divergence in working patterns is that it has coincided almost exactly with a comparable divergence in religiosity.

It's the sort of theory tailormade for somebody with my particular set of biases, so I'm forcing myself to be very skeptical. In any event, do go read the whole thing. It's very well done.

Fattoria di Felsina Berardegna Riserva (Chianti Classico) 1997

It's been Chianti week here at ProfessorBainbridge.com, but this one takes the top prize. Still going strong as it approached age 7, it offered up a bouquet of rose petals and cherries, spiced with a not unpleasant suggestion of damp fall leaves. On the palate, it retained a good core of smooth tannins and plenty of acidity. The flavor profile was dominated by ripe cherries and berries, but with an interesting earthy and slightly gamy undertone. I'm going back to the store where I picked this one up to see if they have a few more - this is a definite repeat player. Grade: A-

Smoking in Taverns for Tots

A friend sent along the citation to an amusing new case: Taverns for Tots, Inc. v. City of Toledo, 320 F.Supp.2d 643 (N.D.Ohio 2004):

In summary, Taverns for Tots, ostensibly a nonprofit organization dedicated to raising money for children's charities, was formed on December 20, 2003. Two individuals--one of plaintiff's directors and a bar owner affiliated with plaintiff--testified at the preliminary injunction hearing on February 5, 2004 that Taverns for Tots was formed primarily as a means to enable smoking in bars and restaurants by taking advantage of the exemptions in the Clean Indoor Air Act for membership associations and private social functions. The City argued that plaintiff's charitable purpose--to raise money for needy children--was secondary to that primary goal of avoiding compliance with the anti-smoking ordinance; thus, the City contended, Taverns for Tots could not qualify as a membership association pursuant to the ordinance.

Bars had been holding Taverns for Tots "events" since December 20, 2003, at which smoking was permitted and to which any member of the public could gain admittance on payment of a one dollar lifetime "membership fee." According to plaintiff, because each nightly "event" was held under the aegis of Taverns for Tots and each person present possessed or had purchased a membership card, each of these "events" was sponsored by a "membership association" (namely, Taverns for Tots) under the Clean Indoor Air Act and was thus exempt from the ordinance.

Clever. And I like the name too (query though whether Toys for Tots would have a trademark infringement action). In any event, the court had no sense of humor and issued an injunction banning the organizers of Taverns for Tots events from permitting smoking at such events. Sigh. Personally, I would have liked to see such a clever defense of private property rights rewarded.

SUVs Kill?

This post is for my (former?) friends at XRLQ and Libertarian Jackass:

According to a University of Virginia study, suburbanites are more at risk of being killed by an SUV than someone living in the city is at risk of being mugged in an alley.

Having said that, however, this news report is making me rethink my whole anti-SUV running schtick:

With the streets of the city of lights and love becoming increasingly clogged with Hummers, Cayennes and Ford Explorers, Paris is trying to find ways to drive sport utility vehicles out of the French capital. ... It’s hard to say how many SUVs are on the road, but a number of the city’s politicians are saying there are too many. In early June, the Paris City Council passed a non-binding resolution calling for local residents to keep the gas-guzzling vehicles off the city streets.

Nibbled to Death by Ducks

My latest TCS Daily column

Earlier this year, California Assemblywoman Judy Chu introduced the "Corporate Elections Fairness Act of 2004," which would have given shareholders a much greater role in board of director elections. The bill went significantly further than the SEC's pending shareholder access proposal (and arguably would be preempted by it). For example, the SEC proposal only allows investors who own 5% or more of a corporation's voting stock to nominate a director candidate, but Chu's proposal would have set the threshold at 2%. The bill also proposed requiring that corporations implement shareholder proposals that win a majority vote even if the board of directors thought the proposals to be unwise.

Chu's law generated opposition from almost all quarters and appropriately so. There can be no doubt that giving shareholders access to the proxy statement to nominate directors is going to be expensive by significantly increasing the number of contested elections. Plus there are all the indirect costs. Companies are already having a hard time attracting independent directors. The shareholder access proposal likely will make that search even harder. Why would somebody be willing to serve on the board if he or she might be the one singled out to be ousted? (I've documented these costs in numerous posts at my blog, which are collected in an archive devoted to the SEC's proposal.)

The election of a shareholder representative also will disrupt the delicate internal dynamics that make boards successful. Its effect will be analogous to that of cumulative voting, which allows minority shareholders representation on the board. Experience with cumulative voting suggests that it often leads to pre-meeting caucuses by the majority and a reduction in information flows to the board as a whole. In turn, this results in adversarial relations between the majority and minority board members, which interferes with effective board governance.

In the face of opposition from such disparate groups as the Business Roundtable and CalPERS Chu has now backed way down:

"Chu ultimately decided to retreat when staff from Calpers told her the giant pension fund preferred to follow the SEC process rather than go down another road in California .... 'We felt something of this nature has to happen at the national level,' explained Calpers spokesman Brad Pacheco.

"Instead, at the suggestion of Calpers, Chu introduced a resolution in support of the SEC rules. That whereas-laden resolution won overwhelming support in both branches of the Legislature, but it was essentially just a symbolic gesture."

Speaking as a Californian, I'm of two minds with respect to this iteration of the law. On the one hand, given California's dire financial situation, I don't like seeing the legislature wasting time on mere gestures. On the other hand, given the mischief the California legislature is capable of causing when they deal with substantive issues, maybe we should have them spend more time on gestures and less on real issues.

"Chu also agreed to amend her bill to require that companies provide a process in which shareholders could merely 'recommend' candidates for election as directors and that they file the process with the secretary of state. Chu maintained that requirement still would help shareholders better understand corporate election procedures.

"In June, the bill went through yet another round of tweaking in the state Senate Judiciary Committee, which eliminated the watered-down 'recommend' clause. Those changes turned it into simply a disclosure bill, which would require publicly traded companies to file a copy of their corporate election procedures -- or those portions of the company's articles of incorporation and bylaws that related to nominating and electing directors -- with the secretary of state."

Of course, corporations already make such disclosures as the federal level. Election procedures are described in the proxy statement and annual report required by the SEC. The corporation's articles of incorporation and bylaws are already filed both with the state of incorporation and the SEC.

Granted, as finally amended the law doesn't do much harm. Corporations will just have to file one more piece of paper in one more place. But to what end? How will shareholders benefit? The information to be disclosed is already available in many places, including various places online. Indeed, most corporate investor relations web sites provide access to this sort of information.

"Well, so what," you ask? So corporations spend a few bucks filing disclosure documents nobody will read. Who cares?

Do you know the expression "nibbled to death by ducks"? California's business climate stinks. As the Sacramento Bee reported in February 2004:

"California firms find doing business here so difficult that 40 percent of those surveyed plan to move some jobs out of state and 50 percent will not add jobs within the state, according to a study released Thursday. The report, issued by the California Business Roundtable, said the cost of doing business in the state is 30 percent higher than in other Western states, with regulatory costs the biggest culprit."

Some of the costs California imposes on its businesses come in big chunks. Taxes, worker's compensation, family leave, and so on. Others come in little pieces -- like Ms. Chu's bill -- but throw in enough such laws and the aggregate costs can really add up.

If California is going to stop putting its business community through the death of a thousand cuts, it is precisely these sorts of small, seemingly innocuous laws that must be eliminated. It is time for Sacramento to get serious about cost-benefit analysis and to stop making gestures at the expense of our economy.