ProfessorBainbridge.com

Books in Brief

Andy Olree, The Choice Principle: The Biblical Case for Legal Toleration -- An argument founded in Evangelical theology for a quasi-libertarian political framework in which sinful choices are not regulated by law except where they victimize others.

Eric Klinenberg, Fighting for Air: The Battle to Control America's Media -- An extended rant against consolidation in the media industry. Plus, some insightful thoughts on the way the new media is challenging traditional media outlets from both the left and right. Worth reading by anybody who cares about the evolution of media.

Andrew Roberts, A History of the English-Speaking Peoples Since 1900 -- It takes a certain amount of chutzpah to write a book that explicitly picks up where Nobel Prize winner Winston Churchill's famous History of the English-Speaking Peoples left off. Roberts is a better historian the Churchill, and a very good writer, but can't match the master's literary skills. Then again, how many others can? In any case, just like Churchill, Roberts has an agenda -- namely, to advance the claim that the English-speaking peoples are the last best hope of mankind. Atlanticist, pro-American, robustly opinionated. A recommended read.

Costco CEO Supports Minimum Wage Boost. But Why?

From the WaPo:

The chief executive of Costco Wholesale, the nation's largest wholesale club, yesterday became the most prominent member of a new organization of business owners and executives pressing Congress to approve an increase in the federal minimum wage.

Jim Sinegal, a maverick entrepreneur who founded Costco in 1983 and has resisted Wall Street pressure to cut wages and benefits for his 130,000 employees, said he signed onto the effort because he thinks a higher minimum wage would be good for the nation's economy as well as its workers.

Nonsense. The Post has completely missed the real story. Costco is (a) playing to the ideological predilictions of its top management, (b) trying to get some favorable publicity in the blue state areas where it does most of its business, and (c) trying to hurt both Walmart and the small businesses with which Costco competes:

From the Seattle Post Intelligencer back in 2004:

Costco Chief Executive Officer Jim Sinegal, 68, is a Democrat who says President Bush's $1.7 trillion in tax cuts unfairly benefit the wealthy. He opposed the Iraq war and supports Sen. John Kerry of Massachusetts for president. And he's the only chief executive of a company in the Standard & Poor's 500 Index to donate money to independent political groups formed to oust Bush, Internal Revenue Service records show. ...

"Wal-Mart is extremely strong in Republican strongholds; they are a red-state retailer," said Amy Bonkoski, an investment adviser at Cleveland-based National City Corp.'s private-client group, which manages about $26 billion, including Wal-Mart and Costco shares.  "Costco is stronger in Democratic states. Costco is a friend to labor. Unions hate Wal-Mart." ...

Costco wouldn't have to raise salaries with Kerry's proposal to increase the minimum wage to $7 an hour, from $5.15 now. It already pays hot-dog vendors as much as $16 an hour, and the lowest wage it pays is $10 an hour.

That's higher than the $9.96 average wage paid at discount stores bearing the Wal-Mart name. ... Wal-Mart has benefited from the president's opposition to raising the minimum wage, since some employees make less than $7 an hour, and from the Republican-controlled Congress' reluctance to make it easier for workers to unionize.

Typically of the MSM, however, the Washington Post made no effort to analyze whether Sinegal was being altruistically or opportunistically. They just assume he must be the good guy, when in fact he's using shareholder money to advance his personal beliefs and at the same time being a ruthless competitor. If you think about it a minute, the real good guys in this scenario are the small business that compete with both Costco and Walmart and that will suffer when the minimum wage hike goes through.

Update: One of the Economist's bloggers thinks both Costco and Walmart will benefit, which strengthens my point that the real good guys are the mom-and-pop businesses that can't afford to pay much more than the current minimum wage:

CEO's who support higher minimum wages are not, as the media often casts them, renegade heros speaking truth to power because their inner moral voice bids them be silent no more.  They are by and large, like Mr Sinegal, the heads of companies that pay well above the minimum wage.  Forcing up the labour costs of their competitors, while simultaneously collecting good PR for "daring" to support a higher minimum, is a terrific business move.  But it is not altruistic, nor does it make him a "maverick".  Costco's biggest competitor, Wal-Mart, also supports a higher minimum wage, and for the same reason.  Wal-Mart's average wage is already above the new minimum; it will cost the company little, while possibly forcing mom-and-pop stores that compete with Wal-Mart out of business.  This seems blindingly obvious to me.  Though I don't expect we'll see "the minimum wage—it's great for Wal-Mart!" in many Democratic campaign commercials.

What?s Wrong with Shareholder Nominations Anyway?

Lisa Fairfax poses that question over at Conglomerate, noting the various reasons HP has offered for ooposing a shareholder proposal "to allow certain shareholders to gain access to the corporation?s proxy in order to nominate up to two directors." This was a fairly frequent topic in the early days of the blog (see the archive for this category), plus the subject of a number of TCS Daily columns over the years, including:

• Does the SEC Know When Enough Is Enough?
• The SEC: From Bad to Worse?

My most complete treatment of the issue of shareholder nominations, however, was A Comment on the SEC Shareholder Access Proposal:

Abstract: The Securities and Exchange Commission (SEC) recently proposed a set of amendments to its proxy rules intended to provide shareholders of public corporations with a limited ability to nominate candidates for a corporation's board of directors and to have their nominee placed on the corporation's own proxy statement and card. This essay reviews the principal features of the proposal and identifies several issues remaining for resolution. The essay concludes that the SEC likely has authority to adopt the proposal, but argues that the costs the rule will impose on corporations outweigh any likely benefits from greater shareholder democracy.

Politicians and Consistency

Glenn Greenwald catches Republican politicians flip-flopping on the scope of Congressonal war powers. When Clinton was bogged down in Somalia, they endorsed expansive Congressional war powers. Now that Bush is bogged down in Iraq, they're emphasizing Presidential power. But so what? Catching politicians talking out of both sides of their mouths is like shooting fish in the proverbial barrel.

Virtually all politicians are shameless flip-floppers; indeed, it seems to be a bona fide job qualification. Consider how Democrats flip-flopped on filibusters of judicial nominations, to take but one example. (See also this list.) Moreover, as John Yoo pointed out in the Pennsylvania Law Review, Bill Clinton took a view of Presidential War Powers nearly as expansive as that of George Bush:

Although on several occasions Congress refused to authorize the use of force, President Clinton argued that he had the sole constitutional power as commander-in-chief to send American servicemen and women into harm's way. While he often signaled that he would welcome congressional support, he also made clear that he would implement his military plans without it. President Clinton further refused to acknowledge that the War Powers Resolution bound his discretion to act. The Clinton administration has rendered the War Powers Resolution a dead letter.

So let's start with the assumption that most politicians on both sides of the aisle will say anything that advances their cause of the moment, without regard to whether it's consistent with positions they've taken earlier. Indeed, most can do so with out so much as a red face.

The only question that really matters is what powers, if any, Congress has to limit the scope of a President's conduct of war. My friend Georgetown University Professor Anthony Arend is a leading expert on national security law. He's blogged that:

... courts have repeatedly said, to quote Justice Jackson in the Steel Seizure Case, that the President "has no monopoly of 'war powers,' '"

He's told the press that:

Congress may lack the power to "micromanage an ongoing conflict" with detailed mandates for deploying forces. However, Arend told TNS, lawmakers could rein in war spending so that the White House "would have no choice but to reduce troops in accordance with that funding reduction."

I take it that Arend would agree with Ann Coulter's observation that:

If Congress doesn't like it, the Constitution gives it two choices: It can cut off funding, or it can impeach the president. Congress controls the purse – it doesn't wage war.

The Republican Congressmen who thought Congress could cut off funding for Clinton's Somalia misadventures were right back then. So are the Democratic (and some Republican, by the way) lawmakers who think they can cut off funding for Bush's Iraqi misadventures.

Sunlight the best disinfectant for hedge fund empty voting

My Examiner column:

One vote per share of stock long has been the dominant rule in American corporations. This link between economic and governance interests generally works well. It ensures that as a shareholder’s voting power increases, so does the shareholder’s proportionate share of the corporation’s earnings. Accordingly, a shareholder with a substantial voting position has a strong interest in ensuring that the corporation performs well.

Increasingly, however, hedge funds and private equity funds are decoupling voting and economic interests. To take a simple example, a hedge fund might borrow shares in Ajax Corporation from another institutional investor. Under standard corporate law rules, the hedge fund is entitled to vote the shares, while the lending investor retains the economic interest. More complicated arrangements using various forms of derivative securities, such as options or futures, are also being used increasingly often.

As Texas law professors Henry Hu and Bernard Black have demonstrated, thisso-called "empty voting" phenomenon is potentially subject to serious abuses. Because the hedge fund has "more votes than economic ownership," Hu and Black explain, the fund could end up with "a negative economic interest and, thus, an incentive to vote in ways that reduce the company’s share price." Suppose, for example, that the hedge fund is selling Ajax stock short. It now has an incentive to drive down Ajax’s stock price and, accordingly, an incentive to cast its "empty votes" in value-reducing ways.

A related problem is the risk of over voting. In some cases, both the lender and borrower of the securities receive proxy materials and attempt to vote the shares. Because tracking of stock lending is often incomplete, companies routinely end up counting both votes. Nobody knows for sure how common over voting has become, but there’s general agreement that it is a growing problem.

The U.S. Securities and Exchange Commission and its global counterparts in other major markets, such as the UK’s Financial Services Authority and Hong Kong’s Securities and Futures Commission, are well aware of the potentials for abuse and are now considering regulatory responses. The problem is that the simplest regulatory solutions all are fraught with the risk of serious unintended consequences.

For example, the simplest solution to empty voting would be to ban the lending of securities. On the one hand, however, it’s not clear that even a complete ban on lending securities would solve the problem. As already noted, hedge funds are using increasingly sophisticated financial derivatives, which likely would provide ways to end run any such ban.

On the other hand, there are lots of legitimate reasons for lending securities. It facilitates short selling, for example, which helps promote market efficiency. Indeed, there’s an emerging consensus among financial economists that short sellers often have identified price-relevant information of which the market as a whole is unaware. By selling short, these sellers help move stock prices in the correct direction and thus make the stock market more efficient.

Instead of attempting substantive regulation, with its potential for unintended consequences for the capital markets and its conflict between federal and state law, regulators ought to go back to Louis Brandeis’ famous aphorism: "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman."

Under current law, Securities Exchange Act Section 13(d) requires that anyone who controls more than 5 percent of a class of voting securities must file a written disclosure statement with the SEC within 10 days after crossing the 5 percent threshold.

This provision was adopted back in the 1960s and has long since been rendered obsolete by technological developments. The 10-day filing window, for example, makes little sense for an era in which computer monitoring of stock positions and the availability of electronic filing makes real time disclosure practicable.

As a first step towards dealing with the issue of empty voting, Congress should authorize the SEC to amend its rules under Section 13(d) to make clear that anyone with the right to vote more than 5 percent of a class of a company’s voting securities must file a disclosure statement with the SEC, regardless of whether the holder has an economic interest in the shares, and that the holder of the economic interest in more than 5 percent of a class of a company’s voting securities also must file a disclosure statement, regardless of whether the holder holds the voting right with respect to those shares.

In addition, the 10-day filing window should be shortened to no more than 48 hours. The person filing such a disclosure statement should be obliged to electronically submit a copy of the disclosure statementto the issuer, which should be obliged to immediately post the statement on its investor relations Web site.

Guest Speaker Ribstein

Today's guest speaker for my corporate governance colloquium is University of Illinois law professor Larry Ribstein, who is presenting his paper: Corporations and the Market for Law, which you can download from SSRN. Abstract:

The state competition for corporate law has long been studied as a distinct phenomenon. Under the traditional view, corporations are subject to a unique choice-of-law rule, the “internal affairs doctrine” (IAD). This rule is explained as a historical accident, or by the special logistics of the corporate contract. The resulting market for corporate law appears to have special characteristics, particularly including the dominance by the single state of Delaware.

This paper challenges the traditional view. It shows that the corporate law market is best understood as a special application of the general market for law. Any differences are matters of degree rather than kind, and are explained by considerations underlying enforcement of all choice-of-law contracts rather than by factors unique to corporations. It follows that theories of corporate competition that ignore the broader law market context are incomplete, and that the competition for corporate law carries lessons for the law market generally. Moreover, the connection between the corporate and other law markets has implications for the nature of corporate law, the constitutional status of the IAD, the scope of the IAD, and for the relationship between state and federal law

Baude's Book Selection

Will Baude repo rts that as he prepared for his exam in Business Organization, he relied on:

The Economic Structure of Corporate Law, by Easterbrook and Fischel, has been something like my bible throughout learning and studying for my exam. It is implausible in places, a little glib in others, but fundamentally a brilliant, brilliant book ....

Indeed, as I acknowledged in my review, Easterbrook & Fischel's book is a class in the field. (So much so that Kent Greenfield recently published a book that serves mainly as an extended progressive answer to E&F, about which much more in due course.) Candidly, I suspect Will made the right choice; Yale being more of a preparatory school for the legal academy rather than an actual law school. If you want to actually learn some law, however, you might want to consider Corporation Law and Economics.

Me versus the Boalt Faculty

Over at Nuts & Boalts, a UC Berkeley law student group blog, Tom Fletcher asked Which Tenured Boalt Faculty Still Publish Articles? Young Mr Fletcher apparently has more free time than most law students I know, since he went out and crunched the numbers to see how many articles each of the 40 tenured Boalt faculty members published per year between 1996 and 2005. Results here.

Finding myself with a little time on my hands this PM, I decided to see how I stacked up against the Boalt faculty. With an average of 2.20 articles published per year (in Hein Online archived journals), I'd come in fourth on the Boalt faculty (out of 40) behind only Farber, Yoo, and Volpp. If I had more time on my hands, I might figure out how the rest of the UCLA law faculty compares to Boalt, but I'm not quite that bored.

Stone v Ritter and Caremark Revisited

When I teach Caremark in Business Associations, I tell my students that there is a critical difference between cases in which the board fails to consider the desirability of law compliance programs and cases in which the board makes an informed decision not to adopt such a program. In an earlier post on the Delaware Supreme Court's opinion in Stone v. Ritter, I suggested that the Court's recharacterization of Caremark as a loyalty-based cause of action changed that result:

First, it seems clear that a conscious decision by the board of directors that the costs of a law compliance program outweigh the benefits will no longer be protected by the business judgment rule. To the contrary, such a decision might result in per se liability. See Stone, 911 A.2d at 370, in which the court stated that "Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith." I suppose this problem could be finessed by holding that a board that consciously decides on the basis of an informed process not to adopt a law compliance program will escape liability because such a board had no "duty to act," but notice how such a solution guts the business judgment rule. The whole purpose of the business judgment rule is to prevent the court from asking whether the board made a reasonable decision. See, e.g., Brehm v. Eisner, 746 A.2d 244 (Del. 2000) ("Courts do not measure, weigh or quantify directors' judgments. We do not even decide if they are reasonable in this context.").

I've got a very bright student who's doing a research paper on Stone under my supervision. She pointed out a clever solution to the problem. Suppose the corporation's general counsel comes to the board and recommends that the board consider adopting a program to ensure that the company complies with law X. The board carefully considers the question and reaches a fully informed decision that the costs of implementing such a program outweigh the benefits. Unfortunately, the company ends up violating law X and is obliged to pay significant fines. Shareholders sue the board, bringing a Caremark claim. What standard of review applies? As noted in the earlier post, there is an argument for treating an informed decision not to adopt the law compliance program as a duty of care issue, such that the business judgment rule applies.

Suppose, however, a Delaware court concludes that failure to adopt a law compliance program - whether informed or not - raises issues of good faith and, per Stone, loyalty. The court would do so, presumably, by concluding that such a decision entails a failure "to act in the face of a known duty to act." If the decision was made by independent and disinterested directors, however, Puma v. Marriott, 283 A.2d 693 (Del. Ch. 1971), suggests that the standard of review ought to be the business judgment rule.

In Puma, a disgruntled Marriott Corporation shareholder brought a duty of loyalty claim based on the corporation’s purchase of six other companies from the Marriott family. At the time of the transaction, the Marriott family collectively owned 44% of Marriott Corporation’s stock. Four of the nine directors were Marriott family members. The acquisition was unanimously approved by the five disinterested directors. The court held that on those facts the business judgment rule was the applicable standard of review.

As I point out in my Corporation Law and Economics text (at page 312):

Some commentators contend the same rule applies to transactions reviewed under § 144(a)(1). Dicta in at least one Delaware supreme court decision seemingly supports this view. It also is supported by a few decisions from other jurisdictions interpreting comparable statutes. This view also is consistent with case law on the effect of shareholder approval under § 144(a)(2). Finally, this interpretation of § 144(a)(1) is consistent with the economic justification for the business judgment rule as developed in Chapter 6. If the disinterested directors have approved the transaction, courts should defer to their judgment, just as they would with respect to any other business decision. All of the economic arguments in favor of the rule of judicial abstention apply here, just as they do to any other business decision made by impartial directors.

In sum, whether the claim is characterized as one based on the duty of care or good faith (as subsumed into loyalty), a claim that the board of directors breached its fiduciary duties by making an informed decision not to adopt a law compliance program should be reviewed under the business judgment rule.

Song of Fire and Ice to Become Film-And the Wait Goes On

CE Petit sent me a link to a story that George RR Martin's Song of Fire and Ice fantasy series will be made into a HBO series. There'll apparently been one season for each novel. Cool. I'm a big fan of Martins' series and of many of the HBO TV series (isn't great that Rome's back?  and who else can't wait for the Sopranos to come back?). But the story also contains this depressing note:

Martin has nearly finished the fifth installment, but won't complete the seven-book cycle until 2011.

2011? Is there anybody since Tolkien who wrote more slowly than Martin? Worse yet, Martin's 58 years old. Let's hope he stays in good shape. Too many sci fi and fantasy authors have shuffled off this mortal coil with series unfinished.

Cafeteria Catholicism and the Minimum Wage

When liberal Catholic politicians support abortion rights, conservatives are quick to accuse them of being cafeteria Catholics. When conservative Catholic politicians oppose increasing the minimum wage, liberals are quick to hurl the same accusation.

The metaphor is an apt one. Many Catholics stroll past the array of teachings offered by the Church, choosing to obey those that appeal to them personally and rejecting those that do not. Unfortunately for cafeteria Catholics, however, the Church makes clear that the cafeteria approach is not an authentic form of Catholicism. To the contrary, the faithful "have the duty of observing the constitutions and decrees conveyed by the legitimate authority of the Church." (Catechism ¶ 2037.)

At the same time, however, the Church encourages lay initiative "especially when the matter involves discovering or inventing the means for permeating social, political, and economic realities with the demands of Christian doctrine and life." (Catechism ¶ 2037.) Clearly, there areas that the Church leaves to the prudential judgment of the faithful.

How do we distinguish between those areas in which faithful Catholics may properly disagree with pronouncements by the Pope or a bishop and those as to which faithful Catholics must give their assent even if their personal judgment is to the contrary?

We begin with the Magisterium or the teachings of the Church. Catholic doctrine divides Church teaching into two basic categories. The sacred Magisterium encompasses the infallible teachings of the Church as pronounced by the Pope acting ex cathedra or by the Pope and Bishops acting together in an Ecumenical Council. "When the Church through its supreme Magisterium proposes a doctrine 'for belief as being divinely revealed,' and as the teaching of Christ, the definitions 'must be adhered to with the obedience of faith.'" (Catechism ¶ 891) Contrary to what many non-Catholics believe, there are relatively few infallible teachings. Indeed, much of the sacred Magisterium is captured in the Nicene Creed. Another well-known example is the promulgation of the dogma of the Assumption of Mary by Pope Pius XII in 1950.

The vast bulk of Church teaching does not rise to the level of the sacred Magisterium. Instead, it consists of the ordinary Magisterium:

Divine assistance is also given to the successors of the apostles, teaching in communion with the successor of Peter, and, in a particular way, to the bishop of Rome, pastor of the whole Church, when, without arriving at an infallible definition and without pronouncing in a "definitive manner," they propose in the exercise of the ordinary Magisterium a teaching that leads to better understanding of Revelation in matters of faith and morals. To this ordinary teaching the faithful "are to adhere to it with religious assent" which, though distinct from the assent of faith, is nonetheless an extension of it. (Catechism ¶ 892.)

The distinction between "obedience of faith" and "religious assent" is an obscure one, which I think we can safely leave to the professional theologians. The Dogmatic Constitution on the Church (Lumen Gentium) teaches that religious assent requires we acknowledge the teachings "with reverence" and "sincerely" adhere thereto.

The difficulty is that Church documents frequently fail to specify whether the teaching in question is to be regarded as part of the sacred Magisterium or the ordinary Magisterium, or something as to which faithful Catholics may properly exercise prudential judgment. There is an old saying in the Church: "When it is not necessary for the Bishop to speak, it is necessary that the Bishop not speak." Unfortunately, the hierarchy honors that wise advice mostly in the breach.

Consider, for example, the recent controversy over the execution of Saddam Hussein. Before Saddam's execution, Cardinal Renato Martino, president of the Pontifical Council for Justice and Peace, opined that it is not morally licit for anyone, "even the state," to kill another person. Is this Magisterial teaching? Arguably not.

The Catechism of the Catholic Church states, in pertinent part, that:

The traditional teaching of the Church does not exclude, presupposing full ascertainment of the identity and responsibility of the offender, recourse to the death penalty, when this is the only practicable way to defend the lives of human beings effectively against the aggressor.

"If, instead, bloodless means are sufficient to defend against the aggressor and to protect the safety of persons, public authority should limit itself to such means, because they better correspond to the concrete conditions of the common good and are more in conformity to the dignity of the human person.

"Today, in fact, given the means at the State's disposal to effectively repress crime by rendering inoffensive the one who has committed it, without depriving him definitively of the possibility of redeeming himself, cases of absolute necessity for suppression of the offender 'today ... are very rare, if not practically non-existent.'" (Catechism ¶ 2267.)

A fair interpretation of that teaching, especially when it is read against Pope John Paul II's writings on the death penalty, is that the Catholic Church as a matter of ordinary magisterial teaching strongly disfavors the death penalty. Specifically, as a matter of ordinary magisterial teaching, the Church commands that the death penalty not be used if imprisonment (or other punishments) adequately protect society against the wrongdoer. Faithful Catholics should give this teaching religious assent.

Notice, however, that the Catechism does not ban the death penalty per se. Instead, it leaves open room for the exercise of prudential judgment with respect to the question of whether, in a particular case, "bloodless means" will not be "sufficient to defend against the aggressor and to protect the safety of persons." Cardinal Renato's pronouncements on Saddam's execution reflect his own prudential judgment, but they need not be regarded as Magisterial teachings to which the faithful are obliged to give religious assent. Instead, faithful Catholics may exercise their own prudential judgment on that issue.

The hierarchy could help the faithful by doing a better job of categorizing specific pronouncements. In the meanwhile, faithful Catholics must exercise discernment in attempting to determine whether a specific pronouncement by Church leaders is something to which they must give assent or something as to which the faithful laity may exercise prudential judgment.

A case in point is provided by Bishop Nicholas DiMarzio, chairman of the US Conference of Catholic Bishops' Domestic Policy Committee, who recent pronounced that the Bishops have "supported the minimum wage since its inception as a just means to protect the human rights and dignity of workers" and, accordingly, that the Bishops have renewed their "support for an increase in the minimum wage." As such, he called on Congress to raise the minimum wage.

Is support for a minimum wage part of the ordinary Magisterium to which faithful Catholics must give religious assent, even if they believe it is bad economic or social policy? Is Bishops' support for an increase in the minimum wage something that requires religious assent? I'll address those questions in next week's column.

Trust, Ethnicity, Globalization, and the Diamond Business

Trust has considerable instrumental value as a way of reducing transaction costs in situations where neither contract nor law function well. In such settings, parties frequently rely on noncontractual social norms to minimize transaction costs; in particular, trust acts as a lubricant to reduce social friction. If I trust you to refrain from opportunistic behavior, I will not invest as many resources in ex ante contracting. “Whoever can be trusted with very little can also be trusted with much ....” If you prove trustworthy, I will not need to incur ex post enforcement costs. Trust thus is not only honorable, it is socially useful.

By its very nature, trust implies vulnerability. If I trust you to perform as per our agreement, I am by definition voluntarily assuming the risk of nonperformance. Trust thus may be defined as “the willingness of one person to increase his or her vulnerability to the actions of another person whose behavior he or she could not control.” Assuming I am risk averse, why should I be willing to risk uncompensated loss? Put another way, in what social contexts and under what conditions is trust most likely to arise?

Trust is essentially social and normative, rather than individual and calculative. It arises out of a set of shared background assumptions and norms. Because trust thus derives from shared values, it is most likely to arise in homogeneous groups. A considerable body of research thus suggests that trust is especially likely to become an important lubricant to market exchange when the business at hand is dominated by a single ethnic and/or religious group.

While the old adage opines “familiarity breeds contempt,” personal proximity to others in fact deeply affects behavior. As people become closer, their behavior tends to improve.

Close-knit, homogenous communities strengthen this instinct in several ways. First, they provide a network of reputational and other social sanctions that shape incentives. Because membership in close knit groups satisfies the human need for belongingness, the threat of expulsion gives the group a strong sanction by which to enforce compliance with group norms. Because close knit groups involve a continuing relationship, the threat of punishment in future interactions deters the sort of cheating possible in one-time transactions. Second, because people care about how they are perceived by those close to them, communal life provides a cloud of witnesses whose good opinion we value. We hesitate to disappoint those people and thus strive to comport ourselves in accordance with communal norms. Finally, there is a transaction costs economics explanation for the importance of closeness in trust relationships. Close knit groups know a lot about one another, which reduces monitoring costs and thus further encourages compliance with group norms. Members of close-knit groups therefore tend to internalize group norms, which allows members of the group to trust one another in ways they would not be willing to risk when dealing with outsiders.

Much of the research on this subject has been conducted in connection with the diamond industry. Hence, I was very interested in a new paper by Barak Richman, Ethnic Networks, Extralegal Certainty, and Globalisation: Peering into the Diamond Industry. Here's the abstract:

For nearly one millenium, the diamond industry's distribution system remained largely unchanged. Ethnic networks, predominated by Jewish merchants, managed the downstream distribution system. Since state courts are unable to reliably enforce executory contracts for diamond sales, these networks succeeded because their community institutions were able to assert extralegal governance. But recent trends in the globalisation of commerce have introduced pressures that might cause the one thousand year-old system to unravel. Low-wage workers from India have displaced higher wage western merchants, consumer demands for political oversight has brought scrutiny to previously secretive networks, and the profitability of global branding campaigns has enabled DeBeers to implement a vertically integrated business strategy that skips the middleman and sells directly to consumers. Since these pressures represent the paradigmatic forces of globalisation, examining changes in the diamond industry offers insights both into the future of ethnic exchange and into globlisation itself.

It's a very interesting and important paper for those of us who are interested in the way social norms reinforce and sometimes compete with law.

Boalt Student Counts Articles

A UC Berkeley student asked himself: Which Tenured Boalt Faculty Still Publish Articles? And worked out a remarkably detailed answer here. Two conclusions. (1) There's more dead wood on the Berkelely faculty than one might have thought. (2) I doubt whether there's any student at UCLA (or most other law schools, for that matter) to whom that question would have occurred. How many law students do you know that actually value research enough to go count 10 years worth of articles by 40+ faculty?

Boalt Student Counts Articles

A UC Berkeley student asked himself: Which Tenured Boalt Faculty Still Publish Articles? And worked out a remarkably detailed answer here. Two conclusions. (1) There's more dead wood on the Berkelely faculty than one might have thought. (2) I doubt whether there's any student at UCLA (or most other law schools, for that matter) to whom that question would have occurred. How many law students do you know that actually value research enough to go count 10 years worth of articles by 40+ faculty?

Barney Frank and CEO Pay

Reuters reports:

Massachusetts Democratic Rep. Barney Frank told Reuters on Thursday he hopes to pass a bill by mid-2007 to give shareholders more say in setting corporate executive pay, a contentious topic for U.S. businesses. "We need to find some way to legislate greater shareholder involvement in setting CEO salaries," Frank said at the annual Reuters Regulation Summit in Washington.

One assumes that Frank is carrying water for unions, for whom shareholder voting on CEO salary is a major policy goal (as Larry Ribstein has explained). Whether or not that's the case, however, it's a very bad idea. Why? See the discussion in the last section of my paper Executive Compensation: Who Decides?