ProfessorBainbridge.com

Those darn shrimp at LAX

I found the conclusion of C.C. Kraemer column Fairy Shrimp vs. Man a little over the top (well, maybe even way over the top). As a regular user of Los Angeles International Airport, however, I couldn't agree more with the basic gist of the column:

The [fairy] shrimp lives -- exists? -- in a depression at the end of a runway [at LAX]. Officials have fenced off 108 acres for its privileged use, even though no shrimp worth eating has been found there, just eggs that haven't yet hatched, even after having been in the spot for years. The U.S. Fish and Wildlife Service wants the area to be designated as a preserve for the fairy shrimp. That probably sounds reasonable, since the property is likely to sit idle because of its location. Who would want it for anything? But an argument by LAX officials demonstrates that this is yet another case of man forcing man to yield to a lower life form.

It's not that the relatively small tract has been set aside. It's the ripple effect that area would have. Designating the area as a preserve for the fairy shrimp would require it to have standing water. That attracts birds. Though they both have wings and fly, birds and aircraft do not mix well.

Sometimes the results are disastrous. Yeah, it makes a mess of the bird. But too often it's equally as ruinous for humans. Jetliners full of passengers have been known to go down after sucking birds into their engines.

Takeoff is a critical moment for a flight. If something is thrown off -- even a bird being chewed up by a turbofan engine with 65,000 pounds of thrust -- it makes the takeoff that much more difficult. The Bird Strike Committee USA, made up partly of federal and aviation industry officials, says that a 12-lb Canada goose hitting an aircraft traveling 150-mph at lift-off is similar to the force created when a 1,000-lb weight is dropped from a height of 10 feet. That should be enough to violate the structural integrity of the hull of any jetliner.

Species preservation is an important goal, but the species I care most about is the human one. Fill in the depression.

Is More Always Better?

My latest TCS Daily column

John Kerry recently told the AFL-CIO that, if elected, he intends to do something about executive compensation:

"I am very concerned about runaway executive compensation. Today, the average CEO makes more than 500 times what the average worker makes, and I think that's wrong. While I don't believe our government should place dollar limits on compensation, I do think there are steps we can take to make the system fair. We must curb abuses where they occur, especially such practices as funneling money to offshore accounts or tax shelters that allow executives to avoid paying their fair share of taxes."

I commend Kerry for recognizing that the government should not get in the business of setting executive compensation. As I've observed before on this blog, how much you get paid depends in large part on the thickness of the market for your services. In a thick market, wages tend to be low because there are many potential employees -- all more or less fungible -- competing for jobs. In a thin market, however, wages tend to be high because many employers are competing to hire a small number of eligible workers. The market for burger flippers is very thick. The market for CEOs of Fortune 500 companies is thin. Very thin. I'd guess the number of people who have what it takes to run a Fortune 500 company isn't much larger than the number of people who can run a NBA fast break. Its just supply and demand, folks.

Unfortunately, Kerry was not content to leave the problem to the markets. Instead, he proposes to get at executive compensation by imposing new disclosure obligations on firms:

"I believe that the SEC should consider requiring companies to provide greater transparency in the reporting of their executive retirement stock purchase and investment plans in order to determine whether executives receive significantly better compensation and retirement benefit packages than other workers in the same company."

Just how much more disclosure Kerry wants is unclear. As it is, executive compensation disclosures already constitute the bulk of most annual shareholder meeting proxy statements.

Indeed, the chief problem with Kerry's proposal is that the existing disclosure rules already provide shareholders with too much information. The assumption behind both the existing rules and Kerry's proposal is that enhanced disclosure will enable shareholders to participate more actively in compensation decisionmaking. Shareholders will complain to the board about excessively high compensation, challenge excessive compensation in derivative litigation, reject excessive compensation plans put to a shareholder vote, and vote out of office directors who approve excessive compensation.

This assumption is dead wrong. Basic financial economics tells us that most shareholders prefer to be passive investors. A rational shareholder will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs. Given the length and complexity of SEC disclosure documents, the opportunity cost entailed in becoming informed before voting is quite high and very apparent. Moreover, most shareholders' holdings are too small to have any significant effect on the vote's outcome. Accordingly, shareholders assign a relatively low value to the expected benefits of careful consideration.

As a result, making disclosures more transparent won't help, while requiring greater volumes of information will make the situation worse. For most shareholders, the investment of time and effort necessary to make informed voting decisions remains a game that is not worth playing. Accordingly, they will do what they always do with corporate disclosure: ignore it and simply vote for management's director slate and management compensation proposals.

Some believe that this shareholder passivity model no longer holds true in light of the growing importance of institutional investors. To be sure, institutional investors are an increasingly important force in the stock markets and, moreover, some institutions are playing a more active role in corporate governance. At the same time, however, the passivity model remains applicable even to most institutional investors. Participating in corporate governance is not a cost-less endeavor. Just as with other shareholders, institutional investors must expend resources to make informed decisions. Other than a handful of public pension funds, most institutions have therefore opted for passivity.

In sum, adopting Kerry's proposal will increase the cost to companies of complying with their disclosure obligations, but will not lead to more informed shareholder decisionmaking. As such, it's lousy securities regulation policy.

On the predictive power of markets

I just noted a Larry Ribstein post that relies on the predictive power of markets; a sentiment seemingly shared by Steve Verdon:

Check out the Iowa market's graph. Remember these markets tend to have somewhat better predictive power than standard political polls. These people are looking at the polls plus additional information that we are seeing in the news. Further, this information in aggregated over a large number of individuals so it is likely the "aggregate information set" is larger than your typical person taking a poll.

You can see the same thing over at TradeSports.com as well. Bush is now around 0.69 and Kerry is continuing his long slow decline to 0.20. Right now the momentum is with Bush and it shows no sign of changing.

But then there's this post by Michael Stastny at Marginal Revolution:

On TradeSports a contract of George Bush in the winner-take-all market is currently selling for around $7. But what does this actually mean? Most traders and researchers would argue that 0.7 is the current "market probability" that the event "George Bush wins the 2004 presidential election" occurs. But this answer drives Charles Manski, an economist who recently also published an article in the September issue of Econometrica, crazy.

He says that under not-so-far-fetched assumptions, the price of a contract reveals nothing about the dispersion of traders' beliefs and partially identifies the central tendency of beliefs. A President.GWBush2004 contract trading at 70 reveals that 70 percent of traders believe the probability of the event "George Bush wins the 2004 presidential election" to be larger than 0.7. The mean subjective probability of this event lies somewhere in the open interval (0.49, 0.91) (price/mean belief region).

Candid admission time. I tried reading Manski's paper, but he's dealing in a level of statistical analysis that's way above my pay grade. And, frankly, I'm having a hard time even parsing Stastny's explanation. (Hey, I went into law precisely because I stunk at numbers. You're looking at a guy who got a C in Calculus and a D+ in Differential Equations.) So can somebody please explain, in simple English, exactly what prediction markets tell us? Try emulating what economic historian Deirdre McCloskey (who is herself an interesting story) calls "the lawyerly rhetoric" of Nobel economics laureate Ronald Coase.

SOX Costs

In a useful post linking to several sources on the costs of complying with Sarbanes-Oxley, Larry Ribstein concludes:

This is all part of two broad stories. First, ... we must recognize that there is an international securities markets that puts competitive pressure on US law. Second, we should recognize the heavy of costs of federal regulation of corporate governance, toward which Sarbox was a significant and misguided step.

Yep. For my take on one part of the problem, see my articles The Creeping Federalization of Corporate Law. Manage rialism, Legal Ethics, and Sarbanes-Oxley Section 307, and/or A Critique of the NYSE's Director Independence Listing Standards. Alternatively, just type Sarbanes in the search box in the left sidebar for a plethora of posts on SOX.

Connecting the Dots: Investors/Bloggers/Elections

Larry Ribstein picks up on the WSJ ($) article reporting "that Bush futures on Tradesports have been rising with the stock market in what's usually a down month." Larry opines:

Although the story leads with speculation that the market likes the prospects of a Bush victory, the article later includes appropriate caveats that correlation is not causation. ... But there is one interesting aspect of the story: its implicit assumption that election futures markets provide valuable information about where the election is headed -- possibly more valuable than all the contradictory polls. I've been repeating this as a mantra, most recently here, and linking both Tradesports and the Iowa Election Market on my sidebar.

Maybe this will be the year when the futures markets, like the bloggers, move into political prominence. Both share an important feature -- they are the distributed, Hayekian, wisdom of the masses. Power to the people, not the so-called experts and the mainstream journalists.

Let's savor that nicely turned phrase: The "distributed, Hayekian, wisdom of the masses." But Larry: What about The Madness of Crowds?

Investors and the election

If you're a passive investor (like me), you park your money in no-load index funds and then just sort of ignore them. If you're an active investor, you spend a lot of time looking for slight edges. The WSJ ($) reports that many investors are now tracking a rather odd source of information:

Looking past corporate profits and interest rates, some investors have begun tracking data on an Irish betting Web site, TradeSports.com, that takes wagers on, among other things, who will win the presidential election. In recent weeks, a chart of President Bush's re-election chances based on TradeSports odds has looked surprisingly like the chart of the Dow Jones Industrial Average.

The two have been moving more or less in tandem for months, and the link seems to have kicked in most strikingly around the start of June -- about the time the election battle lines began to firm up. The TradeSports data show that expectations of a Bush re-election were rising until mid-January of this year, when they topped out at about 75%. The betting then turned against Mr. Bush, and his odds fell to just less than 50% around the end of July. Then the betting swung back his way, hovering at about 70% yesterday.

The stock market has seemed to follow in Mr. Bush's wake. The Dow industrials and Standard & Poor's 500-stock index began their slide in mid-February, a few weeks after Mr. Bush. They pulled out of that slide in mid-August, and the Dow industrials are up 1.1% in September -- a month that has had an average loss of 1.23% since their inception in 1896. ...

TradeSports isn't the same as a poll. It is run as a futures market, similar to one operated by the University of Iowa, in which speculators can buy or sell contracts that pay off depending on who wins. It reflects not just opinions, but the willingness of people to put money at risk, much as investors do in more-standard futures trading.

The interpretation seems obvious: When investors think Mr. Bush is going to win, stocks tend to rise. When the market sees Democratic challenger John Kerry's chances rising, it tends to fret. Even on Wall Street, it would seem, "all politics is local." Mr. Kerry wants to raise taxes on people who make more than $200,000 a year -- including their dividends and capital gains -- and many of those people control Wall Street.

No wonder Bush wants to promote an "ownership society." It's very much in his (and the GOP's) interest for more Americans to become investors.

Corrected and Updated: Sumner Redstone's Stock Trades During

My friend Thomas Lifson (blogger and winemaker) note s some curious trading by Sumner Redstone, Viacom's CEO (and major contributor to the Dems), during the Rathergate episode:

A copy of the SEC?s Form 4 ?Statement of Changes in Beneficial Ownership? posted on [Voacom's] website indicates that the billionaire exercised 341,500 options, and sold the stock on the same day, September 14, 2004. ... It is frankly mind-boggling to contemplate that Redstone would take such a step. There must be some compelling reason for him to have exercised the options and sold the shares, a reason which would immediately cause the SEC to accept it as valid. But we don?t know what it is. ... At the end of trading Friday, Viacom stock closed at $34.73. By selling at $35, Redstone made an extra $92,205 on his shares, compared to what they were worth at the end of the week. His profit on the deal totaled $6,744,625 before brokerage fees.

I agree with Thomas that the timing of the sale is a bit curious, but I suspect there is an innocent explanation. One possibility, for example, is that Redstone has a Rule 10b5-1 plan pursuant to which he routinely liquidates the shares covered by such options. If so, he would have had to effect the transaction so as to maintain the plan's viability, the whole point of such plans being that you always trade according to a pre-set pattern regardless of what's going on at your firm. For an overview of the insider trading rules, including 10b5-1, relevant to the recent trading by Viacom insiders, see this post.

Update: I stand corrected. Dinocrat has persuasive evidence that Redstone's sales were not effected within a 10b5-1 plan. Hence, my speculation was erroneous. Having said that, however, I still doubt whether his conduct would qualify as insider trading. There's still going to be problems of materiality and causation that will be difficulty to overcome.

Two spaces after a full stop?

My post on this torrid subject sparked a number of reader emails. Reader BB writes:

I vote for two spaces after a period. MLS's reasons don't persuade: On their first reason, two spaces are not inefficient if they improve readability by more clearly marking the ends of sentences. On reasons 2, 4, and 5, people can be sloppy and computers can make mistakes under any rule. On reason 3, the burden of proof should rest on the party arguing for a change in the convention.

The proportional font point should go the other way. Two spaces on a typewriter are quite large, but two spaces on a word processor are pretty small, since the space as a character seems to be as small as the smallest letter. You would need about four spaces on a word processor to equal two on a standard typewriter. Giving two spaces on a word processor only yields a space the width of a wide captial letter.

In contrast, reader LM writes:

The information that you posted under "How many spaces after a full stop? With Application to Rathergate" gives a fairly accurate summary of the use of double spaces after full stops. I doubt, however, that the use of double spaces in the disputed memos can tell us anything about their authenticity. Over the past 15 years, I have edited and typeset thousands of manuscripts, most of which were written with word processors and, usually, Microsoft Word. Very rarely has an author not inserted two spaces after a full stop. Typesetters today generally follow the rule that there should be but one word-space after a full stop; authors, typists, and casual users of word processors rarely do.

Finally, Lona Manning of the American Thinker opines:

I agree the forger uses two stops, which may be a clue to his age.

OTOH, many of us are struck by his stupidity in making his forgeries on a computer, not a typewriter; and in producing documents without any typos or strike- overs. As though he had never used a typewriter, had no real familiarity with why it is so fundamentally different from word- processing.

The centered address on two of the memos is actually not centered; it is a little off-center in relation to the body of the letter. I think the forger simply used the space bar to ?eye it up? in the center. Or he typed the address, photocopied it to create letterhead, and printed his letter on them.

My other thoughts on his typing abilities are contained in this article for ?The American Thinker.?

On the Nature of the Common Law

I recently had occasion to reread Professor Melvin Eisenberg's ambitiously titled book, The Nature of the Common Law, which I highly recommend as a short and very accessible introduction to some very complex ideas.

Eisenberg's stated goal "is to develop the institutional principles that govern the way in which the common law is established in our society." In doing so, Eisenberg addresses the functions of courts in American society, modes of legal reasoning and the process of overturning prior precedents. Yet Eisenberg never loses sight of his central thesis, namely that "all common law cases are decided under a unified methodology, and under this methodology social propositions always figure in determining the rules the courts establish and the way in which those rules are extended, restricted, and applied." To say that courts should and do rely on social propositions (such as moral norms and public policy) in deciding common law cases is hardly new. Eisenberg's contribution comes in mapping a coherent course between the Scylla and Charybdis of modern jurisprudence. He explicitly rejects theories claiming that some cases can be decided without reference to social propositions. On the other hand, Eisenberg also rejects theories claiming that legal reasoning is nothing more than a mask for the social and political values of the decisionmaker. Any complex society needs an institution before which claims based on existing societal standards can be heard. In our society, that institution is the courts. "If the courts resolved disputes by reasoning from those moral norms and policies they think best, there would be no institution to which a member of the society could go to vindicate a claim of right based on existing standards." Second, since the judicial system is a peculiarly undemocratic institution, the legitimacy of the adjudicative process requires courts to look to "existing legal and social standards rather than those standards the court thinks best." Finally, prohibiting the courts from employing their personal standards makes legal reasoning fairer and more easily replicable by the profession.
Common law adjudication thus is not merely the ad hoc application of whatever social propositions a particular judge is taken by; rather, he lays out institutional principles that constrain and guide the adjudicative use of social propositions. According to Eisenberg, adjudicators may only employ those norms or policies that "can fairly be said to have substantial support in the community, can be derived from norms [or policies] that have such support, or appear as if they would have such support." Two critical assumptions underlie this claim: (1) that social morality is a meaningful concept; and (2) that judges are capable of discerning and effectively applying social morality. As space does not permit one to do full justice to Eisenberg's defense of those assumptions, suffice it to say that the argument is well-crafted and even-handed.

Eisenberg's second claim is that courts have a duty to utilize only those social propositions that have the requisite degree of social support. "By accepting and retaining office the judge undertakes an ongoing commitment to carry out the rules of the office," one of which is "a moral obligation to faithfully employ the norms of social morality ... whether or not he privately agrees with those norms." One may be skeptical about the force of an oath of office in constraining judicial discretion, but this is not the only arrow in Eisenberg's quiver. A variety of corrective forces come into play when a judge strays from those social propositions having the requisite degree of support. From the aggrieved litigant's perspective, the best outcome will be a reversal on appeal. Even if the decision stands, however, it may nevertheless soon be consigned to the dust bin of legal history. Lawyers will make a decent living arguing that the rule should be overturned or distinguished in future cases. Commentators and other courts may point out the decision's flawed reasoning. In extreme cases, the legislature may step in. In sum, common law decisions do not live in a vacuum. The wider arena of legal discourse acts a significant check on judicial error, whether the "error" is deliberate or accidental.

At first glance, Eisenberg's thesis appears to create substantial problems of doctrinal stability. He is unwilling, however, to make doctrinal propositions entirely defeasible in the face of changing social propositions. Accordingly, he constrains the use of social propositions by giving some counter-balancing weight to the value of doctrinal stability. In areas where parties are unlikely to plan their behavior based on existing doctrines, doctrinal stability may be relatively unimportant and a court should be fairly liberal in bringing out of whack doctrines back into line. But in areas such as property and estates, where planning is common and reliance on doctrinal stability is likely, courts should be more reticent. In these latter areas, techniques such as signaling (in which the court suggests that it will revisit the issue later) or prospective overturning may be more appropriate than an immediate reversal of existing doctrine.

For readers persuaded by Eisenberg, or at least interested in seeing his ideas play out, the book's only major flaw is likely to be its length: It is too short. For example, I would have been interested in Eisenberg's view of the claim that efficiency is the sole acceptable and/or the prevailing norm in common law adjudication. Perhaps the most glaring omission, however, is Eisenberg's failure to discuss in more detail the relationship of statutory interpretation to common law adjudication. Nonetheless, it belongs in every common lawyer's library.

Peter Ackroyd, The Life of Thomas More

As a lawyer and Catholic convert, Thomas More is my patron saint and one of my heroes. As anyone who has read or seen "A Man for All Seasons" knows, More was martyred by Henry VIII for refusing to support the English Reformation. More's critics delight in the supposed irony that More was executed for his beliefs in the same way as certain Protestants were executed on More's orders when he was Chancellor of England. In the modern age, when toleration is regarded as the chief virtue, More's stance is easy to dismiss as illiberal and medieval. Yet, to his credit, in this important biography of More, Peter Ackroyd does not fall into the modernist trap. Historical figures must be judged by reference to the standards of their day and the "permanent things," but not by modern sensibilities. Ackroyd therefore presents More as a man of his times. It was a complex time amd More was a complex man.

I honestly wish I liked this biography better. I find Ackroyd's prose to be dense and heavy going. Especially annoying is his frequent use of quotations that he fails to render in modern English. Fifteenth century English is almost a different language than 21st century English and many of the quotations arealmost unintelligible. Granted, a scholarly work of history should not take liberties with translation. But this is a narrative history for a generalist audience, which appropriately has laxer standards.Having said that, I still recommend Ackroyd's biography and am very glad I finally finished it. One comes away impressed with More's humanity, and inspired by his example. More had flaws beyond his supposed intolerance...as Ackroyd demonstrates, for example, More loved bawdy humor. Yet, when push came to shove, More demonstrated great moral courage. It is an inspiring story. I just wish it were told better.

Wealth effects of takeovers

It has long been known that while shareholders of corporations that are targets of a successful takeover gain substantially?on the order of hundreds of billions of dollars. In contrast, studies during the 1980s and early 1990s of acquiring company stock performance reported results ranging from no statistically significant stock price effect to statistically significant losses. By some estimates, up to half of acquiring companies lost money on takeovers during that period. A more recent study, covering the period 1998-2001, finds spectacular losses for acquiring shareholders but those results are skewed because a few acquirers may particularly bad investment decisions:

ABSTRACT: Acquiring-firm shareholders lost 12 cents around acquisition announcements per dollar spent on acquisitions for a total loss of $240 billion from 1998 through 2001, whereas they lost $7 billion in all of the 1980s, or 1.6 cents per dollar spent. The 1998 to 2001 aggregate dollar loss of acquiring-firm shareholders is so large because of a small number of acquisitions with negative synergy gains by firms with extremely high valuations. Without these acquisitions, the wealth of acquiring-firm shareholders would have increased. Firms that make these acquisitions with large dollar losses perform poorly afterwards.

Why do some acquirers make such spectacularly bad decisions? In my book Mergers and Acquisitions, I advance three explanations for why bidders might make negative synergy acquisitions:

1. The Winner's Curse: An auction of corporate control is the most likely situation in which such an outcome might result. Bidder One makes an offer for Target. Bidder Two then makes a competing, slightly higher bid. Several rounds of competitive bidding follow. In the end, the bidder with the highest reservation price should prevail. Yet, that bidder is the one most likely to overpay. In behavioral economics, this phenomenon is known as the "winner's curse." Suppose Target's stock was trading at $10 before the bidding began. Due to the familiar problems of uncertainty and complexity, nobody knows for sure what Target is really worth. Bidder One's reservation price is $20, Bidder Two's reservation price is $22. All else being equal, Bidder Two should win the auction. Suppose Bidder Two ends up paying its reservation price of $22, but later discovers that Target really was worth no more than $20. Bidder Two has experienced the winner's curse: it won the auction, but lost the war. It overpaid. Target shareholders are better off by $12, but Bidder Two's shareholders are worse off by $2. Net, this is still a value creating acquisition, of course, but that fact may not assuage Bidder Two's shareholders.
2. Acquisitions made for the sake of empire building: Bigger is typically better from management's perspective. Just like putting oriental rugs down on the floor, bigger organizational charts on the wall are a management perk. If size reduces the chances of firm failure, management even has a financial incentive to pursue such acquisitions. As with acquisitions motivated by a desire for intra firm diversification, empire building acquisitions doubtless reduce shareholder wealth. Free markets are self correcting, however. Empirical studies confirm that bidders motivated by considerations other than shareholder wealth maximization themselves tend to become targets.
3. Acquisitions made for the sake of diversification: Around the middle of the 20th Century, the idea grew up that good managers could manage anything. This view was operationalized via conglomerate mergers, in which companies intentionally sought to diversify their product lines and business activities horizontally across a wide array of unrelated businesses. The theory was that a cyclical manufacturer could buy a noncyclical business, making the combined company stronger because some division would always be doing well. Diversification necessarily reduces the maximum gains a conglomerate can produce. When one segment is doing well, it is being pulled down by a segment that is doing less well. To be sure, diversification reduced the conglomerate's exposure to unsystematic risk. But so what? Investors can diversify their portfolios more cheaply than can a company, not least because the investor need not pay a control premium. Management of a conglomerate may be better off, because their employer is subject to less risk, but the empirical evidence is compelling that intra firm diversification reduces shareholder wealth. The self correcting nature of free markets is demonstrated by what happened next: during the 1980s there was a wave of so called "bust up" takeovers in which conglomerates were acquired and broken up into their constituent pieces, which were then sold off. The process resulted in a sort of reverse synergy: the whole was worth less than the sum of its parts.

Does the prospect that some acquirers lose money for their shareholders - and some lose a whole lot of money for them - have any policy implications? Should we do anything from a legal perspective to make it harder for one company to acquire another? No. As we just discussed, markets tend to be self-correcting. Firms that make bad acquisition decisions tend themselves to become targets. The market for corporate control is far more likely to make sound judgments in this area than some bureaucrat in Washington.

How many spaces after a full stop?

A colleague sent around the following email, which prompted some thoughts about writing style that segued into the hot topic du jour:

I was taught as a young dude that there should be *two* spaces following a period that concludes a sentence (prior to beginning a new sentence in the same paragraph). For some reason, the advent of word processors (and perhaps a mania for saving space on the page) has led some people to advocate the reduction of this number to *one* space. I find this unsightly (if not unseemly) and cannot bring myself to break the habit of following the period with two spaces. Is there a consensus on which is the proper style?

The Chicago Manual of Style's website relates:

The view at CMS is that there is no reason for two spaces after a period in published work. Some people, however—my colleagues included—prefer it, relegating this preference to their personal correspondence and notes. I’ve noticed in old American books printed in the few decades before and after the turn of the last century (ca. 1870–1930 at least) that there seemed to be a trend in publishing to use extra space (sometimes quite a bit of it) after periods. And many people were taught to use that extra space in typing class (I was). But introducing two spaces after the period causes problems: (1) it is inefficient, requiring an extra keystroke for every sentence; (2) even if a program is set to automatically put an extra space after a period, such automation is never foolproof; (3) there is no proof that an extra space actually improves readability—as your comment suggests, it’s probably just a matter of familiarity (Who knows? perhaps it’s actually more efficient to read with less regard for sentences as individual units of thought—many centuries ago, for example in ancient Greece, there were no spaces even between words, and no punctuation); (4) two spaces are harder to control for than one in electronic documents (I find that the earmark of a document that imposes a two-space rule is a smattering of instances of both three spaces and one space after a period, and two spaces in the middle of sentences); and (5) two spaces can cause problems with line breaks in certain programs.

As both my colleague's email and the CMS commentary suggests, there was a convention back in the manual typewriter days of using two spaces after a full stop, but the advent of wordprocessing seems to have undermined, if not wholly eliminated, that convention. (I note, however, that the rise of hte internet and concomitant HTML style conventions may have been an even more important factor.) John Rhodes reports:

In late September 1998 I asked several people what I thought was a simple typographic question. I was thinking about doing a quick eye tracking study with a colleague and I wondered if there was any empirical research available that showed that a single space after a period was "better" than two spaces, or vice versa.

While this was originally a question about web usability, I realized that the spacing issue is basically irrelevant! Steve Outing of Planetary News correctly pointed out that almost all browsers will only render one space after the period, regardless of how many spaces you put into the HTML code. Note however, that spaces can be hard-coded into the HTML using " ". ...

One of the next things I realized is that, in general, the spacing after a period will be irrelevant since most fonts used today are proportional. That is, each character is not the same size. Amy Gahran of Contentious kindly indicated that very few monospaced (i.e., non-proportional) fonts are used today on the Internet, except for perhaps Courier. This is generally the case offline as well. Proportional fonts are used much more often. For your information, I did not get any good feedback about the various fonts that are used for other Internet applications and activities, such as chat rooms and email. My guess is that they are mostly monospaced, but it is just a guess.

Like Amy Gahran, Kathy Gill told me that the current typographic standard for a single space after the period is a reflection of the power of proportionally spaced fonts.

"The only reason that two spaces were used after a period during the 'typewriter' age was because original typewriters had monospaced fonts -- the extra space was needed for the eye to pick up on the beginning of a new sentence. That need is negated w/proportional space type, hence [it is] the typographic standard."

While I'm on the topic, here's what one of the folks at The Design & Publishing Center had to say about the history of typographic spacing: "In the days of typewriter manuscripts the extra space was necessary to separate the ends and beginnings of sentences. The space character never changed. With the advent of electronic typesetting, the software attempts to 'fit' the type to specific line lengths, it both expands or contracts the available space to make the type fit. Word spacing is where most of this space 'play' takes place."

The relevance to Ra^thergate is self-evident. In all the reporting on the Killian memos, however, I have yet to see any reportage on the number of spaces following the full stops. Has anybody tried to figure out whether there are one or two? If so, email me and I'll post a link. Update: Steve Minor says there are two spaces!

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.)

Viacom, Insider Trading, and Rathergate

My friend Hugh Hewitt asked that I post something about how the insider trading rules apply to Viacom and CBS employees who have inside information about Ra^thergate. The following is adapted from my book Securities Law-Insider Trading.

The modern federal insider prohibition is based on Securities Exchange Act Section 10(b) and, in particular, SEC Rule 10b-5 thereunder. The proposition that Rule 10b-5 prohibits insider trading achieved broad acceptance following the Second Circuit?s decision in SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The Second Circuit established the so- called ?disclose or abstain? rule by holding that an insider who possesses material nonpublic information must either disclose such information before trading or abstain from trading until the information has been disclosed.

Note that while the rule purports to give insiders an option? disclose the information or abstain from trading?in practice that choice is rarely available. The timing of disclosure is a matter of business judgment, subject to any affirmative disclosure requirements imposed by the stock exchanges or the SEC. Texas Gulf Sulphur, 401 F.2d at 850 n.12. Assuming the issuer has no affirmative duty to disclose the information in question, and its board or top management has decided not to disclose the information, insiders? fiduciary duties to the issuer preclude them from disclosing such information for personal gain. The disclose or abstain rule thus does not really provide the insider with a disclosure option: generally the duty will be one of complete abstention.

In Chiarella v. United States, 445 U.S. 222 (1980), and Dirks v. SEC, 463 U.S. 646 (1983), the United States Supreme Court clarified the insider trading rules, holding that liability could be imposed only if the defendant was subject to a duty to disclose prior to trading. Inside traders thus cannot be held liable merely because they had more information than other investors in the market place. Instead, a duty to disclose only arises where the inside traders breached a pre- existing fiduciary duty owed to the person with whom they traded. Chiarella, 445 U.S. at 232; Dirks, 463 U.S. at 653-55. As the Supreme Court explained in Dirks:

We were explicit in Chiarella in saying that there can be no duty to disclose where the person who has traded on inside information ?was not [the corporation?s] agent, . . . was not a fiduciary, [or] was not a person in whom the sellers [of the securities] had placed their trust and confidence.? Not to require such a fiduciary relationship, we recognized, would ?depar[t] radically from the established doctrine that duty arises from a specific relationship between two parties? and would amount to ?recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.? Dirks, 463 U.S. at 654-55 (citations omitted).

The Chiarella?Dirks framework raises several questions pertinent to the present matter. Who is an insider? Or, put another way, what kinds of fiduciary relationships give rise to the requisite duty to disclose? When, if ever, may insiders lawfully trade?

Who is an Insider? Although the precise parameters of the fiduciary analysis mandated by Chiarella and Dirks remain the subject of debate, it is clear that Section 16 officers owe the requisite fiduciary duty to shareholders of the issuer and, accordingly, are deemed insiders subject to the disclose or abstain rule. As the Supreme Court observed in Dirks:

In the seminal case of In re Cady, Roberts & Co., the SEC recognized that the common law in some jurisdictions imposes on ?corporate ?insiders,? particularly officers, directors, or controlling shareholders? an ?affirmative duty of disclosure . . . when dealing in securities.? The SEC found that . . . breach of this common law duty also establish[ed] the elements of a Rule 10b-5 violation . . . . Dirks, 463 U.S. at 653.

Consequently, ?it is well settled that traditional corporate ?insiders??directors, officers and persons who have access to confidential information?must preserve the confidentiality of nonpublic information that belongs to and emanates from the corporation.? Moss v. Morgan Stanley Inc., 719 F.2d 5, 10 (2d Cir. 1983), cert. denied, 465 U.S. 1025 (1984). You can add to the list constructive insiders, such as lawyers, accountants, and other outsiders who do work for CBS and thus have access to confidential information.

Material Information. Liability for inside trading arises only when the insider trades while in possession of material nonpublic information. Information is material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to act. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). I continue to doubt whether Ra^thergate is material, but we?ll see.

When May an Insider Trade? In Texas Gulf Sulphur, the Second Circuit held that, before insiders may act upon material information, the information must have been disclosed in a manner that ensures its availability to the investing public. Merely waiting until a press release has been read to reporters at a news conference, as did one Texas Gulf Sulphur defendant, is not enough. The information must have been widely disseminated and public investors must have an opportunity to act on it. At a minimum, the court opined, insiders therefore must wait until the news could reasonably be expected to appear over the Dow Jones broad tape?the news service that transmitted investment news to brokers and investment professionals. Texas Gulf Sulphur, 401 F.2d at 854. Unlike some other aspects of Texas Gulf Sulphur, this rule doubtless remains good law today.

Possession v. Use. The SEC long has argued that trading while in knowing possession of material nonpublic information satisfies Rule 10b-5?s scienter requirement. In United States v. Teicher, 987 F.2d 112 (2d Cir. 1993), the Second Circuit agreed, albeit in a passage that appears to be dictum. In SEC v. Adler, 137 F.3d 1325 (11th Cir. 1998), however, the Eleventh Circuit rejected Teicher in favor of a use standard. Under Adler, ?when an insider trades while in possession of material nonpublic information, a strong inference arises that such information was used by the insider in trading. The insider can attempt to rebut the inference by adducing evidence that there was no causal connection between the information and the trade?i.e., that the information was not used.? Id. at 1337.

In 2000, the SEC addressed this issue by adopting Rule 10b5-1, which states that Rule 10b-5?s prohibition of insider trading is violated whenever someone trades ?on the basis of? material nonpublic information. Because one is deemed, subject to certain narrow exceptions, to have traded ?on the basis of? material nonpublic information if one was aware of such information at the time of the trade, Rule 10b5-1 formally rejects the Adler position.

Related posts: Rathergate and SEC Rule 10b-5 and Could Shareholders Sue CBS Over the Forgery?

How many spaces after a full stop? With Application to

A colleague sent around the following email, which prompted some thoughts about writing style that segued into the hot topic du jour:

I was taught as a young dude that there should be *two* spaces following a period that concludes a sentence (prior to beginning a new sentence in the same paragraph). For some reason, the advent of word processors (and perhaps a mania for saving space on the page) has led some people to advocate the reduction of this number to *one* space. I find this unsightly (if not unseemly) and cannot bring myself to break the habit of following the period with two spaces. Is there a consensus on which is the proper style?

The Chicago Manual of Style's website relates:

The view at CMS is that there is no reason for two spaces after a period in published work. Some people, however?my colleagues included?prefer it, relegating this preference to their personal correspondence and notes. I?ve noticed in old American books printed in the few decades before and after the turn of the last century (ca. 1870?1930 at least) that there seemed to be a trend in publishing to use extra space (sometimes quite a bit of it) after periods. And many people were taught to use that extra space in typing class (I was). But introducing two spaces after the period causes problems: (1) it is inefficient, requiring an extra keystroke for every sentence; (2) even if a program is set to automatically put an extra space after a period, such automation is never foolproof; (3) there is no proof that an extra space actually improves readability?as your comment suggests, it?s probably just a matter of familiarity (Who knows? perhaps it?s actually more efficient to read with less regard for sentences as individual units of thought?many centuries ago, for example in ancient Greece, there were no spaces even between words, and no punctuation); (4) two spaces are harder to control for than one in electronic documents (I find that the earmark of a document that imposes a two-space rule is a smattering of instances of both three spaces and one space after a period, and two spaces in the middle of sentences); and (5) two spaces can cause problems with line breaks in certain programs.

As both my colleague's email and the CMS commentary suggests, there was a convention back in the manual typewriter days of using two spaces after a full stop, but the advent of wordprocessing seems to have undermined, if not wholly eliminated, that convention. (I note, however, that the rise of hte internet and concomitant HTML style conventions may have been an even more important factor.) John Rhodes reports:In late September 1998 I asked several people what I thought was a simple typographic question. I was thinking about doing a quick eye tracking study with a colleague and I wondered if there was any empirical research available that showed that a single space after a period was "better" than two spaces, or vice versa.

While this was originally a question about web usability, I realized that the spacing issue is basically irrelevant! Steve Outing of Planetary News correctly pointed out that almost all browsers will only render one space after the period, regardless of how many spaces you put into the HTML code. Note however, that spaces can be hard-coded into the HTML using " ". ...

One of the next things I realized is that, in general, the spacing after a period will be irrelevant since most fonts used today are proportional. That is, each character is not the same size. Amy Gahran of Contentious kindly indicated that very few monospaced (i.e., non-proportional) fonts are used today on the Internet, except for perhaps Courier. This is generally the case offline as well. Proportional fonts are used much more often. For your information, I did not get any good feedback about the various fonts that are used for other Internet applications and activities, such as chat rooms and email. My guess is that they are mostly monospaced, but it is just a guess.

Like Amy Gahran, Kathy Gill told me that the current typographic standard for a single space after the period is a reflection of the power of proportionally spaced fonts.

"The only reason that two spaces were used after a period during the 'typewriter' age was because original typewriters had monospaced fonts -- the extra space was needed for the eye to pick up on the beginning of a new sentence. That need is negated w/proportional space type, hence [it is] the typographic standard."

While I'm on the topic, here's what one of the folks at The Design & Publishing Center had to say about the history of typographic spacing: "In the days of typewriter manuscripts the extra space was necessary to separate the ends and beginnings of sentences. The space character never changed. With the advent of electronic typesetting, the software attempts to 'fit' the type to specific line lengths, it both expands or contracts the available space to make the type fit. Word spacing is where most of this space 'play' takes place."

The relevance to Ra^thergate is self-evident. In all the reporting on the Killian memos, however, I have yet to see any reportage on the number of spaces following the full stops. Has anybody tried to figure out whether there are one or two? If so, email me and I'll post a link. Update: Steve Minor says there are two spaces!