Jennifer Arlen

Endowment Effects Within Corporate Agency Relationships

Behavioral economics is an increasingly prominent field within corporate law scholarship. A particularly noteworthy behavioral bias is the “endowment effect”—the observed differential between an individuals willingness to pay to obtain an entitlement and her willingness to accept to part with one. Should endowment effects pervade corporate contexts, they would significantly complicate much common wisdom within business law, such as the presumed optimality of ex ante agreements. Existing research, however, does not adequately address the extent to which people manifest endowment effects within agency relationships. This article presents an experimental test for endowment effects for subjects situated in an agency relationship that typifies many firms. We find that subjects do not exhibit significant endowment effects. An additional experimental test suggests that this finding may be largely due to framing: subjects situated as “agents” may view entitlements principally in terms of exchange value, thereby dampening endowment.

A Political Theory of Corporate Taxation

This paper examines why the United States persists in taxing corporate income twice -- once at the corporate level and again at the shareholder level. The continued imposition of double taxation is puzzling: the double tax is widely recognized as being but unfair and inefficient, and it places a substantial burden on a powerful interest group, publicly-held corporations. Nevertheless, proposals to eliminate the double tax by integrating the corporate and individual tax invariably die a quiet death. We argue that the resilience of the corporate tax is a manifestation of the most enduring source of problems in corporate law, the separation of ownership and control in publicly-held corporations. As a result of this separation, shareholders and managers often have divergent objectives: in particular, managers are more concerned with promoting new investments. Accordingly, managers do not lobby in favor of integration because it creates a windfall for old capital; rather they lobby for benefits to new capital such as Accelerated Depreciation and Investment Tax Credits. Moreover, some managers will actively oppose integration because they benefit from the retained earnings trap created in certain circumstances by the double tax.

Malpractice Liability for Physicians and Managed Care Organizations

This Article provides an economic analysis of optimal negligence liability for physicians and Managed Care Organizations explicitly modeling the role of physician expertise and MCO authority. We find that even when patients anticipate the risks imposed on them, physicians and MCOs do not take optimal care absent sanctions. Markets and contracts do not provide optimal incentives because market prices are determined at the moment of contracting, but physician expertise and MCO authority depend on non-contractable actions taken post-contract. Negligence liability can induce optimal care if damage rules are optimal. Optimality requires that MCOs be held liable for both their own negligent treatment coverage decisions and for negligence by affiliated physicians. Moreover, we find that MCOs should be liable even when they do not exert direct control over physicians. Finally, we show that it may be optimal to preclude physicians or MCOs from obtaining liability waivers from patients, even when patients are fully-informed and waive only when it is in their interests to do so at that moment.

Corporate Criminal Liability: Theory and Evidence

Jeremy Bentham and Gary Becker established the tradition of analyzing criminal law in utilitarian and economic terms. This seminal book continues that tradition with specially commissioned, original papers that span the philosophical foundations of the use of economics in criminal law, both traditional economic perspectives and behavioral and experimental approaches to the discipline.

The Failure Of The Organizational Sentencing Guidelines

In order to deter corporate crime, corporate sanctions must be structured to induce large corporations to help federal prosecutors detect and punish corporate crime. Specifically, firms must be encouraged to detect and report wrongdoing, and to cooperate with the government’s effort to identify and sanction the individuals responsible for the crime. Firms will not engage in these activities unless they face lower expected sanctions if they detect, report, and cooperate than if they do not. This Article examines whether the Organizational Sentencing Guidelines achieve this objective and shows that they do not. Although the Organizational Sentencing Guidelines offer sanction mitigation to firms that adopt effective compliance programs, self-report, and cooperate, this Article shows that these provisions offer too little mitigation to encourage firms to detect, report, and help prosecute the employees’ crimes. Indeed, the Guidelines’ mitigation provisions are particularly inadequate in the very circumstances where corporate detection and investigation is most important: in cases involving crimes committed by managers of large firms. As a result, U.S. efforts to deter corporate crime are undermined by adherence to the Organizational Sentencing Guidelines. This may partly explain why the Department of Justice adopted an alternative strategy for encouraging corporate reporting and cooperation, one that differs materially from the Organizational Guidelines. To help deter corporate crime, the Sentencing Commission should reform the Guidelines.

Does the Endowment Effect Justify Legal Intervention? The Debiasing Effect of Institutions

We claim that the endowment effect rarely justifies legal intervention in private ordering. We present the first theory, to our knowledge, to explain how institutions inhibit the endowment effect without altering people’s rights to their entitlements. The endowment effect is substantially caused by anticipated regret. We show that people experience regret only when they feel responsible for the decision and can mute regret by trading through institutions that let them share responsibility with others. As entitlement holders typically transact through institutions, we expect most people to make unbiased trading decisions in real markets. We test two common institutions—agency relationships and voting—that divide responsibility between multiple actors. Each caused most subjects to debias and trade in our study. We also show that people intentionally debias by employing institutions in order to share responsibility. Thus, when people can freely transact, private ordering generally overcomes the endowment effect.

Designing Mechanisms to Govern Takeover Defenses: Private Contracting, Legal Intervention, and Unforeseen Contingencies

During the takeover wave of the 1980s, managers developed numerous strategies to fend off unwanted bidders and retain control of their firms. These strategies included the poison pill, often used in combination with the effective classified board. Corporate scholars expressed concern over the serious conflict of interest inherent in managerial control over takeovers, arising from the fact that takeovers often presage managerial termination. Many corporate scholars argued that the poison pill should be prohibited.1 Many also concluded that managers should be required to submit bids to shareholders.2 Responding to the fundamental conflict attending board-enacted takeover defenses, the Delaware Supreme Court initially provided for heightened scrutiny of takeover defenses adopted by the board.3 In Unocal v Mesa Petroleum4 the Delaware Supreme Court announced a twotiered proportionality review of takeover defenses. The first prong entails an assessment of whether the board was responding to a legitimate threat to corporate policy and effectiveness.5 The second prong asks the

Evaluating Data on Corporate Sentencing: How Reliable are the U.S Sentencing Commission's Data?

During a recent study of how 1991 federal sentencing guidelines have affected the penalties that federal courts impose on public corporations, we performed an independent evaluation of the quality of the data on corporate sanctions that the U.S. Sentencing Commission releases to the public. Our initial findings led us to use other, independently-compiled data for our own research. This paper presents the main findings of our evaluation, which focused on the quality of the Commissions 1988-1996 (ICPSR) data on public corporations. First, the Commissions post-Guidelines data on penalties for public corporations appear to be incomplete and non-representative of the underlying case population. For example, the ICPSR post-1991 data appear to exclude a disproportionate number of large fines imposed on public corporations. No similar difficulties in the ICPSR pre-Guidelines (1988-1989) data were found. Shortfalls in the post-Guidelines data on other kinds of defendants, such as individuals, appear to be less marked. Second, the Commissions data are missing variables that may explain a substantial part of the case-by-case variation that occurs in sentencing. The data reveal little about the harm caused by the offense, which is often estimated in court papers. Also missing is information about the identity of the sentencing judge and about the identity of the corporation being sentenced. We review the history of the Commissions efforts to collect data on federal sentencing, highlighting institutional constraints and other factors that appear relevant to the difficulties we have found in the data that the Commission releases to the public.

Regulating Post-Bid Embedded Defenses: Lessons from Oracle versus PeopleSoft

This article shows that courts should not adopt a rule of strict shareholder choice that requires managers to obtain shareholder consent for actions taken post-bid that could deter a hostile acquisition. Managers need to be able to act unilaterally to protect the target when a hostile bid threatens its value. Such threats require managerial action, unfettered by a shareholder approval requirement, when the target needs to be able to respond quickly. The conclusion that shareholders can benefit from granting managers unilateral authority to adopt some takeover defenses, even when shareholders are well-informed, is well-illustrated by the Oracle-PeopleSoft contest. PeopleSofts shareholders would have been worse off had their managers not been able to defend the firm from the threat posed by Oracles bid because PeopleSofts shareholders could not have acted sufficiently quickly to preserve the firms value. In addition, this article shows that shareholder choice proponents cannot remedy the over-regulation problem by amending the rule to grant managers authority to adopt some post-bid defenses. Such a rule would create a zone of weakly regulated low-cost defenses within a strict shareholder choice regime, thereby encouraging managers to employ substitute defenses that may be more costly for the firm than are traditional takeover defenses.

Private Contractual Alternatives to Malpractice Liability

Leading law and economics scholars claim that the best way to reform medical malpractice liability is to permit patients and medical providers to determine the scope of malpractice liability by contract. Contractual liability is superior to any form of tort liability for malpractice, it is argued, because contractual liability benefits those patients not well served by existing tort law, but does not hurt patients who benefit from malpractice liability because these patients can, and will, impose liability by contract. This chapter shows that contractual liability is not necessarily better than tort liability because it can make patients worse off. Proponents of contractual liability asserts that contractual liability cannot make patients worse off because they assume that liability obtained by contract affords patients the same benefits as liability imposed by tort. This is not the case. Medical providers often will be unable to design contracts that enable patients to obtain the same benefits from contracted-for liability as they can from tort liability because tort liability benefits patients through the incentives to invest in care (to benefit all patients) provided by the threat of liability for injuries to other patients, now and in the future. Providers may not be able to replicate this collective, multiperiod liability by contract. Patients unable to replicate the benefits of tort liability by contract may rationally reject contractual liability, even when they would have benefited from (and voted for) tort liability for malpractice. If so, contractual liability makes these patients worse off. Patients also are worse off if they are not sufficiently informed to contract in their own best interests. Accordingly, while malpractice liability reform is essential, policymakers cannot assume that it would be better accomplished by private contracting because contractual liability and tort liability are quite different products.