Adam B. Badawi

Relational Governance and Contract Damages: Evidence from Franchising: Relational Governance and Contract Damages

A substantial body of theoretical, qualitative, and experimental research has investigated whether reliance on legal threats “crowds out�? informal, norm-based ways of regulating behavior or, instead, whether the ability to enforce law formally enhances the ability of private parties to use these informal approaches. There has, however, been little quantitative, real-world work that looks into this question. This article begins this process through a study of how franchisors regulate the incentives that their franchisees have to cut corners on the brand’s quality and uniformity standards. One solution to this problem is to threaten to pursue a breach of contract action for violation of these standards, which allows the franchisor to obtain a damage award against a franchisee. Alternatively, a franchisor can rely on more informal means, such as awarding an extra franchise outlet to those franchisees who behave well. There is a tradeoff between these two mechanisms; the informal rewards are costly to provide, but easy to enforce, while contractual threats are cheap, but their enforcement is expensive. Moreover, the literature on relational governance suggests that the use of formal legal threats may undermine an agent’s willingness to abide by reciprocation norms along noncontractible dimensions. These theories suggest that formal and informal mechanisms will act as substitutes and this study, which uses a newly collected data set of franchise agreements, provides strong evidence for that assertion. The analytical insight that permits this inference is the presence of liquidated damages provisions as an indicator of the willingness to use formal law. Courts have shown hostility to the use of the default rule of expectation damages, but they will enforce liquidated damages terms, which means that these provisions are a credible threat to use formal legal sanctions. This study finds that a limited number of franchisors use these terms and that their presence correlates negatively and significantly with variables that are associated with informal, nonlegal means of incentivizing franchisees.

Debt Contract Terms and Creditor Control

The law and finance literature characterizes debt covenants as a means to manage agency conflicts between creditors and shareholders. While both banks and bondholders make use of these covenants, they do so in quite different ways. Banks typically monitor their debtors closely and rely on financial maintenance covenants to protect their interests. When these covenants get triggered, banks can use the leverage of accelerating the loan to achieve their governance goals. This ability to monitor and renegotiate suggests that tailoring precise ex ante contract restrictions is not of paramount importance because a bank and a debtor can negotiate around those restrictions based on ex post contract conditions. Bondholders, in contrast, face substantial barriers to monitoring and renegotiating with their debtors because these bondholders tend to be large groups of passive investors who face substantial collective action problems. As a consequence, ex ante restrictive terms in the contract are likely to be the primary means through which bondholders can address potential conflicts with shareholders. These differences in contracting technologies suggest that the restrictions in bond contracts are more likely to respond to changes in background legal rules. This paper tests this theory by treating two Delaware decisions that limited the default duties that the directors of Delaware corporations owe to creditors as a shock to the contracting conditions for Delaware firms. Difference-in-difference and triple difference tests suggest that restrictive terms in bond contracts for Delaware firms increased in reaction to this change, while there was not a detectable shift in the strictness of loan agreements.

Unceasing Animosities and the Public Tranquility: Political Market Failure and the Scope of the Commerce Power

Introduction ............................................................................................ 1333 I. The Historical Development of the Commerce Clause ................... 1337 A. The Original Purpose of the Commerce Clause ....................... 1337 B. The Historical Development of the Supreme Courts Commerce Clause Jurisprudence .............................................. 1339 1. G ibbons v. Ogden ............................................................... 1339 2. The Progressive Era Court ................................................. 1339 3. The N ew D eal Court .......................................................... 1342 4. The M odem Era ................................................................. 1344 5. United States v. Lopez ........................................................ 1345 6. United States v. Morrison ................................................... 1347 II. The Scope of the Commerce Clause: Identifying the Flaws of the Political Safeguards and Narrow Scope Approaches ............ 1348 A. The Political Safeguards Approach to the Commerce Clause: Allowing Congress Broad Powers ............................. 1349 B. The Narrow Scope Approach to the Commerce Clause: Limiting the Reach of Congress ............................................... 1351