ProfessorBainbridge.com

Crime? And Punishment

The recent convictions of ex-Tyco executives Dennis Kozlowski and Mark Swartz and of ex-Adelphia executives John and Timothy Rigas highlight once again the growing extent to which the criminal law is being invoked to deal with problems of corporate governance.

Few serious persons would deny that fraud and theft are appropriate subjects of the criminal law. When corporate executives loot the corporation, as the Rigas were convicted of doing, they should go to jail.

Unfortunately, however, ambitious prosecutors have not limited themselves to cases of fraud or theft. Consider Martha Stewart, for example, who was sent to jail on the rather dubious charge of having misled prosecutors with respect to alleged insider trading for which she was never charged.

The Tyco case looks a lot more like the latter than the former. To be sure, Dennis Kozlowski appears to have been a prize pig, with extravagantly bad taste. But throwing million dollar parties and buying $6000 shower curtains is not criminal.

Unlike most media outlets, which simply parroted the prosecution line, while waging a little class warfare, Forbes magazine did some serious investigatory journalism in the Tyco case. What Forbes found was evidence of bad corporate governance -- directors who were often uncertain of what they were doing and so on -- but neither theft nor fraud. Unfortunately, as blawgger Larry Ribstein documents, the jurors just didn't get it.

As blawgger Tom Kirkendall points out, these convictions have a ripple effect. They make it easier for prosecutors "to bludgeon business interests into cooperating with a criminal investigation even if those business interests do not believe that they have done anything wrong."

Translating Kirkendall's point into economic terms, the criminalization of bad corporate governance has increased the expected sanctions faced by corporate executives. The probability of conviction has gone up because ambitious prosecutors can bring to bear the full panoply of coercive measures available only in criminal litigation, while the nominal sanction has gone up dramatically.

Just how much the nominal sanction has gone up is illustrated by a CNN report on Kozlowski's likely fate:

        Unlike Rigas and other recently-convicted corporate executives like former WorldCom CEO 
        Bernard Ebbers, Kozlowski is now headed for state prison. ... Because states typically 
        prosecute crimes like murder and rape, state prisons are where the most violent 
        offenders are and where the living conditions are described as brutal. Security, by necessity, 
        is extremely tight. ... "The fed system is unpleasant, but at least you're physically 
        safe there," said Gourevitch, who's now in private practice in Manhattan. "In the state 
        system, nobody would say you're physically safe."

Put bluntly, Dennis Kozlowski faces spending the rest of his life worrying about prison rape.

If we were confident that prosecutors could tell the difference between corporate criminality and mere bad corporate governance, and we were confident that prosecutors would content themselves with going after only the former, we might not care if the Kozlowskis of the world spent their days looking over their shoulders (so to speak). Yet, as the Kozlowski story illustrates, it's very hard to tell the difference between criminality and bad governance.

Indeed, as corporate law has long recognized, it can be difficult to tell the difference between good and bad corporate governance. As corporate law also has long recognized, there are serious costs associated with imposing high sanctions on executives.

Business decisions rarely involve black-and-white issues; instead, they typically involve prudential judgments among a number of plausible alternatives. Given the vagaries of business, moreover, even carefully made choices among such alternatives may turn out badly.

At this point, the well-known hindsight bias comes into play. Decisionmakers tend to assign an erroneously high probability of occurrence to a probabilistic event simply because it ended up occurring. If a jury knows that the plaintiff was injured, the jury will be biased in favor of imposing negligence liability even if, viewed ex ante, there was a very low probability that such an injury would occur and that taking precautions against such an injury was not cost effective.

Hence, there is a substantial risk that juries will be unable to distinguish between competent and negligent management because bad outcomes often will be regarded, ex post, as having been foreseeable and, therefore, preventable ex ante. If liability results from bad outcomes, without regard to the ex ante quality of the decision and/or the decisionmaking process, however, managers will be discouraged from taking risks. If it is true that lack of gumption is the single largest source of agency costs, as somebody once said, rational shareholders will disfavor liability rules discouraging risk-taking, as Judge Ralph Winter opined in Joy v. North:

        [B]ecause potential profit often corresponds to the potential risk, it is very much in the 
        interest of shareholders that the law not create incentives for overly cautious corporate 
        decisions. ... Shareholders can reduce the volatility of risk by diversifying their holdings. In 
        the case of the diversified shareholder, the seemingly more risky alternatives may well be 
        the best choice since great losses in some stocks will over time be offset by even greater 
        gains in others. ... A rule which penalizes the choice of seemingly riskier alternatives 
        thus may not be in the interest of shareholders generally.

Hence, when juries review the merits of even bad corporate governance, they run the risk of effectively penalizing "the choice of seemingly riskier alternatives."

In sum, shareholders deserve protection from theft, but not from risk taking, even when the risk in question is how much to pay an executive. Unfortunately, it's not clear that prosecutors know the difference -- or even care.

SEC Wins One ... Mostly

The DC Circuit has rejected the bulk of the US Chamber of Commerce's suit challenging the SEC rules requiring that mutual funds must have a majority of independent directors and an independent chairman. The court acknowledged that the SEC generally has no authority over corporate governance of public corporations under the Securities Exchange Act of 1934, a point on which I've written, but the court went on to hold that the SEC did have authority under the Investment Company Act to adopt the rules as to mutual funds. The analysis on that point strikes me as basically right. Even though I thought the rules were a really bad idea (as I wrote here), I figured the SEC did have authority to adopt them. The court went on to say that it will review the SEC action to ensure compliance with the APA. Thanks to CE Petit for the link.

Director Primacy and Takeovers

Larry Ribstein is quibbling with my director primacy theory of the corporation. While acknowledging that it "is a useful quick description of corporate governance," he opines that:

The problem with board primacy^[1] is that it cannot answer questions that arise on the margins, when the logistical problems that support the theory don’t control the result. One possible example was hostile takeovers, which seemed to solve the accountability problem.  But not really, because it left significant issues about when to intervene in the board's decisions to defend against takeovers in various ways.

Obviously, I don't agree that takeovers are a problem for the model. I developed some initial arguments on how resistance to unsolicited takeover bids by a target corporation's board of directors can be fit into the model in a Stanford Law Review article entitled Director Primacy in Corporate Takeovers: Preliminary Reflections. A somewhat more elaborate version of the analysis was published in my Mergers and Acquisitions treatise (at pp. 340-386). My main project this summer has been an article tentatively entitled "Unocal at 20," which is currently at 95 pages and growing. Look for it in late summer on SSRN. In the meanwhile, here's the gist of the argument:

In sum, the conflict of interest present when the board responds to an unsolicited tender offers differs only in degree, not kind, from any other corporate conflict. Although skepticism about their motives is thus appropriate, their conflict of interest does not necessarily equate to blameworthiness. Rather, it is simply a state of affairs inherently created by the necessity of conferring authority in the board of directors to act on behalf of the shareholders. To be sure, that state of affairs could be avoided by declining to confer such authority on the board in this context. Yet, if the legal system deprives the board of authority here, it will be hard-pressed to decline to do so with respect to other conflict transactions. As has been the case with other situations of potential conflict, we therefore would expect the courts to develop standards of review for takeover defenses designed to detect, punish, and deter self-interested behavior. Because the risk may be greater in this context, stricter than normal policing mechanisms may be required, but this does not mean that we must set aside authority values by divesting the board of decisionmaking authority.

---

[1]

I prefer the term "director primacy" because it makes a sharper contrast with the prevailing view known as "shareholder primacy," even though board primacy probably is more descriptively accurate.

A Wolf in Sheep's Clothing?

Law Professor Marci Hamilton claims to be a conservative, having once told a Federalist Society meeting: "As a conservative, I am completely behind the notion that we need to reduce welfare, completely behind the concept that we need to reduce taxes, completely behind the concept that we need to increase individual liberty and choice." (Link) Yet her new book on church-state relations, God vs. The Gavel, which reportedly seeks to erect a seemingly insurmountable  very strong wall between church and state, is endorsed by a very dubious crowd:

"Professor Hamilton's book dazzles with lucid, original, and humane intelligence. The legal profession, academia and the general public will all enjoy learning from it. Let us hope the U.S. Supreme Court does not deviate again from its present conclusion on religious liberty as Hamilton explains it." Rita Swan, Ph.D., President, Children's Healthcare Is a Legal Duty "Marci Hamilton has heroically and truthfully confronted the widespread American myth that all things done in the name of religion are good and deserving of constitutional protections. She has accurately named the harm done in the name of religion and how this harm is protected and enabled by the courts and law enforcement by way of the inaccurate application of the First Amendment. God vs. The Gavel is essential reading for those who insist that religion be true to its fundamental mission and not about victimizing people for the sake of power, privilege or financial gain." Thomas P. Doyle, O.P., J.C.D., C.A.D.C., Canon Lawyer, Advocate for those abused by Clergy "Marci Hamilton is an original and provocative First Amendment scholar whose views have enriched and enlarged the debate about religious liberty. She saw the potential constitutional problems with laws like the Religious Freedom Restoration Act well before many others did. Her voice simply cannot be ignored." Nadine Strossen, Professor of Law, New York Law School, President of the American Civil Liberties Union "A terrific discussion of the constitutional issues concerning religion that are so important right now in American society. Whether one agrees or disagrees with Professor Hamilton, one has to admire the clear, careful, and provocative way she approaches these key issues concerning the government and religion." Erwin Chemerinsky, Professor of Constitutional Law, Duke University, School of Law "God vs. the Gavel will open your eyes, stun your soul, and strengthen your belief that no one, not even priests and ministers, are above the law. If you care about justice for those victimized by religion, you must read this book." Karol Jackowski, author of The Silence We Keep: A Nun's View of the Catholic Priest Scandal "This is a truly important, if provocative work, which is essential reading for anyone who wishes to delve beneath the surface of the contemporary battle over religion and values." the Honorable Edward R. Becker "A timely, hard hitting, passionate, yet scholarly inquiry into the clash between religion and the state. Hamilton, whose writing style is engagingly lucid and compelling, raises controversial questions and her powerful answers will enrich our understanding of the issues and provoke debate. No one will or should completely agree with Hamilton but no one concerned about the interface between religion and civil society can responsibly ignore her cogent arguments." Dean David Rudenstine, Benjamin N. Cardozo School of Law, Yeshiva University

Left-liberals virtually to the man (and woman). Worse yet, virtually all are the type of left-liberal who wants to drive religion out of the public square.

Rudenstine, for example, is the guy who recently said: "Faith challenges the underpinnings of legal education. Faith is a willingness to accept belief in things for which we have no evidence, or which runs counter to evidence we have." He's been appropriately pilloried over at Mirror of Justice (Rick Garnett's post is a good place to start.)

Thomas Doyle is described by Ric hard Neuhaus as "a much-lionized champion and cheerleader for sundry dissident [Catholic] organizations and the expert witness of choice for trial lawyers extracting millions from the Church and its insurance companies."

Kate O'Beirne blasted Karol Jackowski for issuing an "indefensible indictment of the entire Catholic community as co-conspirators in order to press a liberal nun's perennial case against the male priesthood."

They say you're known by the company you keep. I find Professor Hamilton to be in very odd company here. So I'm looking forward to seeing what real conservatives with expertise in church- state relations, like Gerry Bradley or the book reviewers for First Things, make of her analysis. (Here's a possible preview.)

Update: I edited this post to make clear that I had not had a chance to read Prof. Hamilton's book when it was written. The point of the post was to raise the company you keep question.

Franco-American Hostility

We just don't like each other very much:

The TNS-Sofres survey of 1,000 people in each country showed only 31 percent of French people have any "sympathy" for Americans, down from 39 percent in 2002. Only 35 percent of Americans like the French, a drop from 50 percent in 2002, according to the poll, published in the Le Monde newspaper. (Link)

My take? I find it a great pity that a country so blessed by God with natural beauty, the ability to produce the world's greatest food and wine, and so many other advantages should have been infested with such a people. Hence, as I said the other day on the anniversary of Waterloo, I stand with Wellington:

We always have been, we are, and I hope that we always shall be detested in France.

French Wine Strikes

Dr. Vino offers a thoughtful analysis of the violent wine strikes in France. It's a sad story. Update: Christian Depken is also posting on this story.

Nexus of Contracts Theory

Gordon Smith has a thoughtful critique of nexus of contracts theory in a post over at the Conglomerate.

My take on nexus of contracts theory is most concisely summed up in the article from which Gordon quotes, The Board of Directors as Nexus of Contracts. On the one hand, I think Gordon is right to suggest that nexus of contracts theory is of limited utility so long as we focus on the notion that the corporate entity is the nexus of contracts. As I explain, what's more important is the observation that the corporation has a nexus of contracts.

After all, to say that the firm is a nexus is to imply the existence of a core or kernel capable of contracting. But kernels do not contract – people do. In other words, it does us no good to avoid reifying the firm by reifying the nexus at the center of the firm. Hence, we must search for the person or persons who serve as the nexus of the set of contracts making up the firm. Our search will be facilitated if we first identify the central characteristic of “firmishness.”

It is in the process of identifying that central characteristic that I depart most significantly from Gordon's analysis. I simply don't agree that the Alchian and Demsetz model is all that useful.

According to the Coasean theory of the firm, firms arise when it is possible to mitigate these costs by delegating to a team member the power to direct how the various inputs will be utilized by the firm. One team member is empowered to constantly and, more important, unilaterally rewrite certain terms of the contract between the firm and its various constituents. By creating a central decisionmaker – a nexus – with the power of fiat, the firm thus substitutes ex post governance for ex ante contract. Uncertainty and complexity are no longer as problematic, because the central decisionmaker can exercise its power of fiat to mandate a chosen adaptive response to new circumstances. Opportunism is deterred by the prospect of ex post sanctions, obviating the necessity of drafting a complete contract ex ante.

Alchian and Demsetz famously argued that a firm has no power of fiat; instead, an employer’s power to direct its employees does not differ from a consumer’s power to direct his grocer. They may well be right that Ronald Coase erred in treating the firm as a non-market institution in which prices and contracts are of relatively little consequence, but there is no necessary contradiction between a theory of the firm characterized by command-and-control decisionmaking and the contractarian model. The set of contracts making up the firm consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the firm’s many constituencies cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. It is precisely the unenforceability of implicit corporate contracts that makes it possible for the central decisionmaker to rewrite them more-or-less freely. The parties to the corporate contract presumably accept this consequence of relying on implicit contracts because the resulting reduction in transaction costs benefits them all. It is thus possible to harmonize the Coasean and contractarian models without having to reject a theory of the firm characterized by fiat.

To be sure, coordination need not imply fiat, as illustrated by the democratic decisionmaking processes of many partnerships and other small firms. In the public corporation, however, fiat is essential. All organizations must have some mechanism for aggregating the preferences of the organization’s constituencies and converting them into collective decisions. Kenneth Arrow identified two basic mechanisms for carrying out this task: “consensus” and “authority.” Consensus is used where each member of the organization has identical information and interests, which results in preferences that are easily aggregated. In contrast, authority-based decisionmaking structures arise where group members have different interests and amounts of information. Because collective decisionmaking is impracticable in such settings, authority-based structures are characterized by the existence of a central agency to which all relevant information is transmitted and which is empowered to make decisions binding on the whole.

The necessity of an actual nexus – a center of power capable of exercising fiat – thus follows in large part from the asymmetries of information and interests among the corporation’s various constituencies. Shareholders care about the value of the residual claim on the corporation. Customers care about the quality and quantity of the goods produced by the corporation. Workers care about salary and conditions of employment. And so on. Under such conditions, efficient decisionmaking demands an authority-based governance structure in which information is channeled to a central decisionmaker empowered to make choices binding on the firm as a whole.

In sum, under conditions of asset specificity, bounded rationality, and opportunism, the ability to adapt becomes the central problem of organization. In large public corporations, adaptation is effected by fiat. Obviously, fiat within firms has limits. Some choices are barred by contract, such as negative pledge covenants in bond indentures. Other choices may be barred by regulation or statute. Still other choices may be unattractive for business reasons, such as those with potentially adverse reputational consequences. Within such bounds, however, adaptation effected through fiat is the distinguishing characteristic of the firm.

Accordingly, the utility of nexus of contracts theory is that it allows us to conceptualize the corporation as a vehicle by which the board of directors hires various factors of production. Hence, the board of directors is not a mere agent of the shareholders, but rather is a sui generis body – a sort of Platonic guardian – serving as the nexus for the various contracts making up the corporation. The board’s powers flow from that set of contracts in its totality and not just from shareholders. My theory of director primacy grows directly out of that insight.

BTW, it appears that the director primacy model is catching on among my fellow academics. Harry Hutchinson recently posted an interesting article to SSRN entitled Director Primacy and Corporate Governance: Shareholder Voting Rights Captured by the Accountability/Authority Paradigm, which extends the model to some useful new areas. And, of course, Wayne Hanewicz did yeoman work in a critical refinement of the model in Director Primacy and Omnicare. Margaret Blair has been quoted as opining that: "We have a director primacy model in this country, not a shareholder primacy model." Director primacy. Catch the wave.

EU Critique

Paul Johnson's analysis of the state of the EU is a must read. Money quote on how the EU elites reacted to the French and Dutch referenda:

Jacques Chirac reacted by appointing as prime minister Dominque de Villepin, a frivolous playboy who has never been elected to anything and is best known for his view that Napoleon should have won the Battle of Waterloo and continued to rule Europe. Gerhard Schr�der of Germany simply stepped up his anti- American rhetoric. What is notoriously evident among the EU elite is not just a lack of intellectual power but an obstinacy and blindness bordering on imbecility. As the great pan-European poet Schiller put it: "There is a kind of stupidity with which even the Gods struggle in vain."

Big Bird on the Chopping Block

Democrats are whining that GOP budgeteer plans to cut public broadcasting's access to the federal teat are all about politics. Of course it's political. With a Republican President and Republican majorities in both the house and senate, why should the federal government go on subsidizing one of left-liberalism's chief mouthpieces? And as for Democrat Congressman Ed Markey's question -- "Does the Republican Party really want to give Big Bird, Oscar the Grouch and Clifford The Big Red Dog the ax?"  -- I have two thoughts. First, whenever a Democrat starts talking about kids, hold on to your wallet, because he's looking for an excuse to spend your money. Second, the Big Bird question is really just the Big Lie in action. In fact, as I've pointed out before, Big Bird will do just fine if we kick him out of the federal nest. All baby birds eventually have to leave the nest and Big Bird's way past his nestling expiration date.

KPMG Threatened with Indictment

News that KPMG may be indicted makes Joe Grundfest's op-ed from the other day even more timely.

... prosecutors can bring down or cripple many of America's leading corporations simply by indicting them on sufficiently serious charges. No trial is necessary.

This prosecutorial power arises from a combination of market forces and legal realities. Corporations that depend on banking, brokerage, insurance, or other licenses are particularly vulnerable because an indictment that puts the license at risk puts the firm at risk too. Firms like Andersen that rely on pristine public reputations are vulnerable if competitors can pounce on their legal travails to gain market share. Firms that do business with the federal government can be debarred and then can't sell their services to their key customer. Firms that need access to the short-term money market learn that an indictment can quickly cut off their capital supply. To be sure, not all firms are equally vulnerable, but America's most powerful banks, brokerages, insurers, auditors and government contractors are among the most defenseless in the land.

Prosecutors are aware of their power, as are potential corporate defendants. Both sides have therefore reached an entente cordiale in which no major corporation has been forced out of business since Andersen's demise. Instead, corporations have entered into deferred-prosecution agreements, paid huge penalties, and undertaken fundamental internal reforms, all under conditions that allow the corporation to survive.

... The prosecutor's decision to indict is largely immune from judicial review. The prosecutor acts as judge and jury. Traditional due process safeguards, like the right to confront witnesses, can't protect the potential corporate defendant. The innocent can therefore be punished as though they are guilty, and penalties imposed in settlements need not bear a rational relationship to penalties that would result at a trial that will never happen.

Tom Kirkendall and Larry Ribstein, as usual, have good posts on this story. From Kirkendall:

So, the dubious governmental policy of criminalizing merely questionable business practices may result in some big companies not being able to to find an accounting firm capable of providing adequate audit services at all.

And from Ribstein:

If the obstruction claim is, in fact, a strong one -- flat out lying and cancealment vs. following a document retention policy in the Andersen situation -- then it's too bad Justice squandered its credibility in its zeal to get Andersen.

Why are so Many Lefties so Rude?

Fine, you're a public employee who disagrees with Gov. Arnold Schwarzenegger's  ballot proposals. Why do you have to ruin 600 students' graduation?

Gov. Arnold Schwarzenegger's return to his alma mater turned into an exercise in perseverance when virtually his every word was accompanied by catcalls, howls and piercing whistles from the crowd. ... Inside the stadium, the drone from hundreds of rowdy protesters threatened to drown out the governor's voice at times. ... At times during Schwarzenegger's speech, cheers and boos mingled, and the graduates themselves appeared eager to hear the governor. Many applauded at one point when the noise from the bleachers briefly subsided. (Link)

Not all liberals are jerks, of course. Indeed, most of the ones I know are basically decent - albeit grossly misguided - folks. But there sure seems to be an awful lot of people on the Left who take pleasure in being rude and disruptive. And there are a few who seem sure bets to go postal one of these days.

Grundfest on Prosecutorial Power

Joe Grundfest's NY Times column on the ability of prosecutors to destroy a business simply by filing an indictment is another must read; money quotes:

Andersen's demise did serve as a stern reminder to corporate America that prosecutors can bring down or cripple many of America's leading corporations simply by indicting them on sufficiently serious charges. No trial is necessary. ...

The current situation of the insurer American International Group is a case in point. Would you buy an insurance policy from a company that might be crippled by a criminal indictment that the New York attorney general, Eliot Spitzer, decides to file tomorrow morning? Neither would I. If the government insists that A.I.G.'s chief executive be fired as part of the price of not indicting the firm, the chief executive is gone. It doesn't matter that he ranks among the most powerful executives in America. A.I.G. has no realistic choice but to cooperate fully with the government, even if evidence might later demonstrate that the government's theories were legally infirm or that factual allegations couldn't withstand cross-examination. Who, after all, wants to be put out of business when indicted, only to be vindicated years later by a jury verdict or appellate ruling? ...

... The prosecutor's decision to indict is largely immune from judicial review. The prosecutor acts as judge and jury. Traditional due process safeguards, like the right to confront witnesses, can't protect the potential corporate defendant. The innocent can therefore be punished as though they are guilty, and penalties imposed in settlements need not bear a rational relationship to penalties that would result at a trial that will never happen.

More on Spitzer

Dominic Basulto's fine TCS column is a must read; money quote:

Spitzer has attacked business practices that appear to skirt the boundary between black and white and, at the same time, attempted to build cases around rarely prosecuted activities. As the Wall Street Journal pointed out in a recent op-ed piece, though, "the criminalization of widely accepted business practices ex post facto is both unjust and offensive to the rule of law." In the case of Sihpol, it was the prosecution of illegal trading in mutual fund shares after the widely accepted 4pm trading deadline. For some time, it has been a dirty little secret that brokers routinely receive same-day pricing for trades that occur after 4pm, giving them an unfair advantage over rivals who play by the rules. For jurors in the case, this obviously posed a problem -- was Sihpol actually doing anything wrong if the securities laws at that time did not explicitly establish a 4pm trading deadline? Recognizing that jurors would not be able to render a guilty verdict, Spitzer was forced to give key witnesses in the trial immunity from prosecution -- a step that only served to increase doubts about Spitzer's case.

At will employment: Should there be a public policy exception for gun owners?

David Kopel blawgs a West Virginia case holding that 7-11 could not terminate an at-will employee for violating company policy by using a firearm to resist a hold-up. Kopel doesn't explicitly provide normative commentary, but the overall tone of the post seems to imply support for the decision. Glenn Reynolds likewise seems pleased: "an employee's right of self defense trumps the employer's right to order employees not to defend themselves."

Not being much of a gun fancier, I have a somewhat different take. Namely, this is yet another judicial blow against freedom of contract and private property rights. It's also a blow against workers. The economic effects of judicially created exceptions to the at-will employment doctrine are well-established.

There are predictable economic effects associated with the increasing acceptance of the wrongful-termination doctrine. In effect, it creates for workers some degree of property right in their existing jobs. These additional rights tend to increase the costs to employers of hiring labor. For example, the potential threat of legal action resulting in liability awards to aggrieved employees now becomes a part of the cost calculus that employers must make when considering the hiring of new workers. Also, the threat of such actions by employees makes it more difficult for employers to adjust their usage of labor in an efficient manner to fit changing market conditions. To a certain extent, the labor input into the productive process no longer can be treated as a variable input. Rather, it has acquired some of the characteristics of a fixed input.

The presence of additional labor costs associated with the employment relationship requires a response by employers. There are two options open to them. One is through changes in the level of workers' compensation. Added labor costs perceived by those who hire labor may be passed on to employees by downward adjustments in labor compensation. The other possibility is to reduce the number of workers hired. The mix of these two options will depend on the nature of the elasticities of demand for and supply of labor. This is spelled out in the Technical Appendix. Using what we view as a reasonable set of these elasticities, also described in the Technical Appendix, it appears that about 85 percent of any additional labor cost arising out of the emergence of the wrongful-termination doctrine will be passed on to employees in the form of reduced wages and benefits for workers. The remainder represents what can be thought of as "net uncompensated costs" to the employer and will negatively affect the willingness of employers to hire workers. ...

Lawyers, labor unions, and other groups have successfully sought changes in the legal environment in which business operates to subvert the sanctity of private contracts, particularly the ancient doctrine of employment-at-will. In a sense, these developments are a form of stealth taxation. They have imposed very significant and real burdens on the American people. ... This is stealth taxation because it is a burden that was not imposed in a manner that was clear and open to the taxpayers. Legislatures did not in a single historic vote decide to radically revise our system of contracts and property rights. Moreover, it is highly regressive taxation, falling heavily on the poor and disadvantaged. (Link)

Another paper summarizes the reasons this form of stealth taxation is highly inefficient:

Employment-at-will dominated other potential terms of exchange because it was efficient. If an employee can be dismissed at any time and for any reason, then said employee has every reason to be productive. Productive employees have little to fear from arbitrary dismissal, since profit-seeking employers can only hurt themselves by dismissing them. Even today, employment-at-will is embraced and long-term contracts avoided in most cases outside of union and government employment.

If at-will contracts are not the best arrangement for those involved, the parties are always free to modify their agreement to mutual advantage. Transaction costs between the two parties are extremely low, and advocates of intervention have never been able to document any substantial third-party effects that justify interference on efficiency grounds. The at-will contract allows more-or-less continuous minor adjustments of contract terms in any direction on a mutually agreeable basis. The arrangement is self-enforcing because a mix of formal and informal controls link payments to employee value and effort rendered. The arrangement avoids the problems inherent in explicit contract language and its inevitable unforeseen gaps, as well as the incentive deficiencies and shirking problems accompanying a fixed duration of employment. While average U.S. job tenure is eight years, it is voluntary markets, not unjust dismissal laws, that sustain such relations. (Link)

You might say, "well, this is just a little exception to at will employment and it protects Constitutional rights." If so, you would be wrong. It would take a remarkably extremist understanding of the Second Amendment, as well as an utter misunderstanding of the state action requirement, to believe that one has a Constitutional right to possess and use firearms on your employer's property. (Update: To be sure, the employee in this case got the firearm away from the robber. The emphasis on a self-defense public policy exception to at-will employment, however, logically could be extended to persons who use concealed caryy weapons. Hence, the broader point.)

In any case, it is the steady erosion of carving out one "little exception" to the at will doctrine after another that has essentially eviscerated that doctrine.

The new public policy doctrines prohibit employers from dismissing employees for performing acts protected by public policy or for declining to commit acts prohibited by public policy. While the public policy exceptions may be the least controversial incursions against at-will employment, problems with these exceptions abound. The term "public policy" evades precise and uniform definition. Can an exception be declared by legislative action only? Or can it emanate from judicial and other sources? The open-ended nature of public policy exceptions is typified by the California court that in Peterman v. Local 396 (1959) declared that anything that contravenes "good morals or any established interests of society" constitutes action against public policy. Since Palmattere v. International Harvester (1981), Illinois courts have expansively defined public policy as "that which is right and just and collectively affects the state’s citizenry." And in Nees v. Hocks (1975), an Oregon court declared that an employer can be held responsible for dismissing an employee "for a socially undesirable motive."

From an economic point of view, a public policy prohibition on dismissal might have an efficiency rationale based on third-party effects. Consider a relatively uncontroversial example: no dismissal for employee absence due to jury duty. The rationale behind these laws is that jury service is a public service, public good, or externality-rich action that allegedly serves the general interest. But even if this proposition is accepted, the cost is not spread across the entire community; rather, it is forced on the juror-employee and his firm’s owners. The tax, or "taking," in other words, is suffered by the absent employee and the unlucky business owners who might otherwise have replaced that employee. The cost of jury duty has been arbitrarily externalized by the courts, legislature, and general public. (Link)

In sum, this decision is no reason for celebration. Oh yes, by the way, while Glenn celebrates this as a victory for individual rights vis-a-vis employer rights, he should know that 7-11's policy is endorsed by the National Association of Convenience Stores:

The vast majority of convenience store robberies are completed without any injury and this is due to the industry's success in training employees not to resist.  (Link)

Indeed, a government study links the likelihood of a convenience store employee being injured to employee resistance. Update: And on that note, a memo to XRLQ: If you believe my "take" of supporting a policy that apparently reduces employee deaths and injuries while simultaneously standing up for conservative values like freedom of contract and property rights is obscene, or even close to it, you're no Potter Stewart.

Cheaters

I like playing poker on-line, but I want a fair fight. Unfortunately, a bunch of computer weenies are fighting dirty:

Of the millions of gamblers who have rushed to play Texas Hold 'Em and other fast-growing poker games online, Roger Gabriel isn't the most intimidating.

The 30-year-old Newport Beach engineer started playing for money only a month ago. He lurks online at the tables for the chicken-hearted; even there, where the biggest ante is 4 cents, he can't win consistently.

But Gabriel has a potentially powerful alter ego. In his spare time, he's perfecting a computer program to go online and play the game for him. ...

Gabriel is one of an increasing number of computer professionals who design poker robots, or "bots," that pose as human gamblers but can play endlessly without tiring or losing concentration ? for real money. ...

The cat-and-mouse game between robots and online game sites is not limited to poker. Whenever any free multi-user computer game gets big enough, cheaters use programs and other means to boost their rankings, collect useful game tools or exact revenge on competitors.

Gabriel, for one, cobbled together an unbeatable Scrabble robot, which he inflicted on Yahoo Games opponents.(Link)

What is it about the computer industry that turns people into (or maybe just attracts) lying, cheating, thieving little twerps shits like Gabriel? Unable to compete with real people, they have to hide behind their computers. (He's probably got a virtual girlfriend too.)

Ironically, of course, the online casinos will end up having to resort to their own computer geeks to detect and oust the bots. And so the weary world turns.

Update: I'm very saddened by the number of emails I've received defending the geeks writing these poker bots. To be sure, my tone was uncharacteristically pugnacious, which prompted a bit of editing, but on the merits I remain unrepentant. The geeks are breaking the rules in order to make money off other players who are playing within the rules. If that's not cheating, what is it? Theft? Lying? In my book, the geeks writing these bots are showing the same piratical attitude that caused the computer industry to lead the league in financial fraud during the tech bubble. It's bad enough that the bot creators feel no shame, but the willingness of others to condone this sort of misbehavior is a sad commentary on the state of ethics and common decency.