Category: Behavioral Law and Economics

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A Berkshire Opportunity Cost: Listed Family Firms

aaaaaThe following is adapted from “Berkshire’s Blemishes,” a working paper delineating the costs, rather than the vaunted benefits, of Warren Buffett’s Berkshire Hathaway as a management model.  

Warren Buffett loves family businesses whose owner-managers care more about their constituents than about profits, recognizing instead that customer care tends to translate into economic gain. Those entrepreneurs, in turn, love Berkshire Hathaway, Buffett’s company, because it offers intangible benefits such as managerial autonomy and a permanent home. When family businesses sell to Berkshire, they know they can still run them as they see fit and will not be sold if prospects falter: Berkshire has not sold a subsidiary in forty years and promises not to.

Buffett hates using Berkshire stock to pay for acquisitions, however, since few companies can match the time-tested premium currency Berkshire has come to represent. In fact, Berkshire’s worst acquisition was paid for in stock and Buffett still translates the cost into current values: $443 million paid in 1993, equivalent to more than $5 billion in Berkshire stock now. Preferring to pay cash, Berkshire is often able to acquire family businesses at a discount because selling shareholders value Berkshire culture. Buffett also hates auctions, plagued by frightful dangers like the winner’s curse, which can push bids well above value, rationally calculated.

Sensible as these tenets are, there is always an opportunity cost, in this case forsaking listed family firms–publicly traded companies controlled by a family. Unlike those owned solely by close-knit groups who all wish to sell to Berkshire, directors of listed family businesses owe duties to non-family shareholders when selling control. In most states, led by Delaware, they are duty-bound to get the best value for shareholders.  (The doctrine is known by famous cases illustrating it, including Revlon and Paramount v. QVC.)

In a stock deal where all holders share gains in future business value, directors could consider Berkshire’s special culture in valuing the transaction. But with cash, all such future value goes to Berkshire’s shareholders, not selling public stockholders, who would also gain nothing from the autonomy or permanence that family members prize in a sale to Berkshire. So directors resist an all cash sale at a discount and seek rival suitors at higher prices, even stimulating an auction to drive price up—repelling Berkshire’s interest.

An example can be drawn from Berkshire’s 2003 acquisition of Clayton Homes, a publicly traded family business bought for a modest (seven percent) premium to market. Many Clayton shareholders objected; one, Cerberus Capital Management, told Clayton it wanted the chance to make a competing bid; another sued. The result was a six-month delay in getting to a shareholder vote, which narrowly approved the Berkshire deal. Many Clayton shareholders were disappointed, but Cerberus opted not to outbid Berkshire, and the court dismissed the lawsuit.

The scenario remains unattractive to Berkshire, however, given the risk of litigation, delay and rival bids. After all, courts might require directors to take affirmative steps, presenting the risk of an auction, which in itself suffices to deter Berkshire from bidding in the first place. The upshot: the publicly traded family business is outside Berkshire’s acquisition model, amounting to an opportunity cost for what would otherwise be a sweet spot. On balance, it is probably a price worth paying, but it’s useful to know the price.

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books on a wide range of subjects relating to business and law. 

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What Do Contract Formalities Do?

In 1941, Lon Fuller published his classic Consideration and Form. Among other things, the article articulated three famous functional claims for consideration: it evidences bargains, channels parties’ behavior, and cautions signers by “check[ing] against inconsiderate action,” and “induc[ing] the circumspective frame of mind appropriate in one pledging his future.”  How? By signaling to prospective signers of contracts that the law was drawing near.  Thus, he hypothesized that seals (“symbol[s] in the popular mind of legalism and weightiness”), the “requirement of a writing,” “attestation, notarization,” and recitals of consideration all induce individuals to feel and behave in a more committed way to the underlying term supported by the formal recitation.

I’ve been studying what individuals think about contract formalities in a series of papers.  That work, combined with other recent scholarship about contracting behavior, made me skeptical that contract language reciting obligation — or disclaiming it — had the straightforward effects that Fuller proposed.  So, with Zev Eigen (Northwestern/visiting Yale), I decided to test Fuller’s foundational & empirical intuition.  In A Fuller Understanding of Contractual Commitment, Zev and I suggest that the conventional account is unrealistic:

“Contract recitals are ubiquitous. Yet, we have a thin understanding of how individuals behave with respect to these doctrinally important relics. Most jurists follow Lon Fuller in concluding that when read, contract recitals accomplish their purpose: to caution against inconsiderate contractual obligation. Notwithstanding the foundational role that this assumption has played in doctrinal and theoretical debates, it has not been tested. This Article offers what we believe to be the first experimental evidence of the effects of formal recitals of contract obligation — and, importantly too, disclaimers of contractual obligation — on individual behavior. In a series of online experiments, we found that participants were less likely to back out of an agreement, forgoing personal gain, when they were endowed with a small extra sum of money at the time of contracting, and when they acknowledged that they were not forming a contract. They were more likely to back out of their original commitment when their agreeing was accompanied by a recital of consideration, and in a control condition in which the natural consideration of bargained-for exchange prevailed. Younger, male respondents were generally more likely to back out of their agreements across all conditions than were women and older participants. The reported experimental results suggest both the descriptive weakness of theorized accounts of private control over contract enforceability and the general value of experimental work about contracting behavior.”
The paper suggests that to the extent that we think formal devices permitting private party control over enforceability are useful, we might want to think carefully about developing ones that signal “law” more clearly to 21st century eyes.  I’d love to get your comments — the paper is still in draft form.

 

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CIV!!! Or How Simulations May Help Government and Personal Choices

Could Civilization and the SIMs be part of a better informed future? I loved Civilization and played way too many hours of it in college. Turns out that the Colombian government has developed “computer games which are designed to teach pre-teenagers to make sensible choices about everything from nutrition to gang membership.” I wonder whether running a simulation of choices and outcomes over and over would shape behaviors or teach other gaming instincts. For example, most people might find that if they follow certain paths they end up in safe, but relatively happy middle class life and retirement. Heck, the game, Life, was a truly random version of what growing up is (then again maybe everything is so stochastic that Life is correct to rely on the spin of a wheel to see whether one is a doctor or teacher or has kids). Still, a game that reinforced the experience of putting money away now, not having it to play with, but having savings in retirement, i.e., the tradeoffs were more palpable, might sensitize people to choices. I never played SIMs, only Sim City, but if SIMs lets you smoke, take drugs, drink too much, have unsafe sex, etc. and gain near term rewards but then find that the long-term payoffs were poor, that would be interesting. Of course, some outcomes might be you’re a superstar who dies early or worse ends up on a horrid reality show. And, many may say “I was a wild child, had a blast, and ended up on T.V.? Cool!”

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Child Safety, Part III

How might tort law respond, if at all, to the preferences of parents and the general population to invest about twice as much in child safety as adult safety? (see this post for a summary of the data, and this post for a discussion of whether those preferences are normatively defensible).

Here’s my take, which you can read more about here:

Because the studies that I’m drawing from concern the allocation of safety-related resources, they have their most direct implications when we view tort law as (at least partially) a means to make people safer by deterring risky behavior. Those studies create two main implications, one for levels of care and one for damages.

Under a deterrence rationale, the standard of care in tort law reflects what we want potential tortfeasors to invest in accident prevention. The investment patterns from my first post in this series suggest that, at least as a prima facie matter, people want potential tortfeasors to invest twice as many resources in preventing accidents when children are the primary potential victims, even when both children and adults are equally vulnerable.  And if my second post in this series is right, we have reasons to respect those preferences. So when children are among the foreseeable class of victims, courts should require a heightened level of care. Although courts appear to respond to a child’s increased vulnerability to harms—they blindly run out into the street to reach ice cream trucks, for example—I have not found evidence that courts have picked up on the extra value that we appear to place on child safety. I’ve also looked at practitioner treatises, and so far I cannot find any mention that courts or juries are more likely to find a defendant negligent if the victim was a child. So, as a prima facie matter, there are reasons to question whether judges and juries are applying a sufficiently stringent level of care in cases involving children.

To motivate potential tortfeasors to take a heightened level of care for children, damages for child victims should be about twice as high as damages for adult victims. Currently, tort damages tend to exhibit child discounts or mild child premiums. This should not be a surprise. We ask juries to set damages in particular ways that constrain their discretion. For wrongful death, we generally ask them to set damages by looking at the economic contributions that the decedent would have made to her relatives. This puts a very small value on dead children, and results in child discounts even after we add non-economic damages. For permanent injuries, some back-of-the-envelope calculations suggest that juries tend to award children 20-25 percent more than adults. This is approximately what we would expect if juries were awarding damages based on the number of years that a victim will have to live with her injuries, and then discounting those future yearly payouts to arrive at a single lump sum.   But that child premium is significantly lower than the 2 to 1 ratio that a deterrence-oriented tort system might strive for. So, as a prima facie matter, there are reasons to question whether damages for child victims are high enough to generate the amount of deterrence that people appear to desire.

Of course, there is much more to say.

A fuller deterrence analysis would require examining a host of additional factors, such as whether regulatory agencies or market forces or the threat of criminal liability already provide extra protection for children, whether risk compensation or substitution effects operate differently for the adult and child populations, the differences between contractual settings like medical malpractice and stranger cases, how to handle “hidden-child” cases (which would be partially analogous to thin-skull cases), etc. I invite readers to offer their thoughts on these issues. But as a first cut, there are reasons to think that tort law does not offer the desired mix of protection for adults and children.

We could also ask what civil recourse and corrective justice accounts of tort law might contribute to the discussion. But I will leave that for another day.

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Data, A/B Testing, and Sales

A company called Adore Me that was founded in 2010 now has sales ($5.6 million) to rival La Perla has done well in part because they use data and A/B testing. Rather than rely on the intuition of photographers and designers, the company takes versions of an offering and shows them to consumers to see what works. Here are the surprising claims. Blonds don’t sell well. A picture of a model with her hand on her hip will sell less than if she places her hand on her head. According to Fast Company:

Through its research, Adore Me has found that the right model matters even more than price. If customers see a lacy pushup on a model they like, they’ll buy it. Put the same thing on a model they don’t, and even a $10 price cut won’t compel them. Pose matters as well: the same product shot on the same model in a different posture can nudge sales a few percentage points in either direction. Another test found that a popular model can sell a more expensive version of the same garment.

Adore Me also has a plus sized model (although I am sure that others can tell me best whether the company’s definition of size 12 and above is a good one) and presumably will see whether folks may buy more lingerie from someone with a body other than a Barbie-esque one. Of course they may find that the image machine controls how we shop, but I am curious to see whwther they will find ways to challenge and tweak what resonates with consumers. Now that may be unlikely as the author of the article, Rebecca Greenfield, wrote “Scrolling through the site, the models could all be related—long legs, olive skin, dark hair, insanely hot.” Yet when it came to race, the article suggests that pose, styling, and the emotional connection with the photo mattered more than race for selling a given item.

As with all data, the practice raises some difficult questions. Seeing how people behave can help sell. Assuming that one’s offering does not influence how people behave is a mistake. The ethics of what one does with data about buying habits and current preferences is a topic for another post and many papers are being written on the topic. For now, be aware of the practices. For Facebook thought it was cool to run thousands, if not hundreds of thousands, of tests on users. As Ian Ayres noted, people can use Google Ads to see what titles work best for a book. So maybe we care more about emotional manipulation than the variation in ad content. Maybe we care more about whether we see ads for the same item and same price as others than whether that ad is highlighted in red, blue, or green. Maybe we should know that poses and lighting can influence our desires and buying habits. Although business experiments are not new, how they are done and for what purpose forces us to re-examine practices. Along the way, we will re-visit markets versus manipulation versus power versus nudging versus culture versus shaping as we better see what is happening and then ask why and whether about those outcomes.

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Evolving Contract Schemas

A Meeting of the Minds

A Meeting of the Minds?

With co-authors, I’ve been working on a series of experimental papers about contract law that appear to be converging on a theme: what individuals think “contract” means has purchase in the real-world, and that contractual schema is evolving.

A schema is nothing more than a mental model – a framework – to help us organize and process information. A contract schema is the set of background assumptions that we fill in when we think about a legally operative bargain. For those of us who grew up in a largely off-line world, our contract schema involve “doing the paperwork,” “getting it in writing,” and “signing on the dotted line.” (See this article for details). Indeed although most contracts law professors make fun of the metaphor of the meeting of the minds, it captures a real heuristic for a certain segment of society. That so even though form contracts have been part of modern life since the 50s, and almost none of us ever actually negotiate contracts that could end up in court. Indeed, when I started teaching in 2004, students routinely would say “she signed it, she must be bound to it,” even in cases like Specht.  Since this mental model is quite a ways from the reality of online contract, consumers may think they are in contracts when they aren’t, and visa versa.

But what happens when contracts widely explored in pop culture – and presented to you in your formative years – were never signed, never reduced to writing, never negotiated.  The cheerios arbitration debacle, facebook’s demystified terms, your cellphone contract, your cable company’s impossible-to-escape relationship.  What happens when every time you think “contract,” you don’t call up the mental image of a “signature on vellum” but instead “loki on steroids.”  And when companies, realizing this, increasingly pushed “no contract” plans that were actually contracts, just without penalty clauses attached.

Perhaps citizens born after 1980 will have dramatically different attitudes toward contract than those born before. If that’s true, we’ll increasingly find cohort effects in contracting behavior online, as lay intuitions about how to respond to “contract” increasingly turn on the age of the promisee. For those coming of age offline, “click to agree” calls up memories of signature, and consequently infuses bargains with personal honor; for those born digital, “click to agree” means “nothing good is about to happen to me.” Those attitudes toward contract will play out in behavior – in likelihood to breach, to shirk, and to behave opportunistically.

At some point we expect to have direct evidence worth sharing in support of this argument! For now, I thought start discussion by fast forwarding fifteen years, when many judges born in the digital age will have assumed the bench. What changes in contract doctrine follow from changes in contract’s schema? Then again, will there be any contract cases left to decide, or will they all been sucked into arbitration’s black hole?

 

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Economic Dynamics and Economic Justice: Making Law Catastrophic, Middling, or Better?

Contrary to Livermore,’s post,  in my view Driesen’s book is particularly powerful as a window into the  profound absurdity and destructiveness of the neoclassical economic framework, rather than as a middle-ground tweaking some of its techniques.  Driesen’s economic dynamics lens makes a more important contribution than many contemporary legal variations on neoclassical economic themes by shifting some major assumptions, though this book does not explore that altered terrain as far as it might.

At first glance, Driesen’s foregrounding of the “dynamic” question of change over time may, as Livermore suggests, seem to be consistent with the basic premise of neoclassical law and economics:   that incentives matter, and that law should focus ex ante, looking forward at those effects.   A closer look through Driesen’s economic dynamics lens reveals how law and economics tends to instead take a covert ex post view that enshrines some snapshots of the status quo as a neutral baseline.  The focus on “efficiency” – on maximizing an abstract pie of “welfare”  given existing constraints —  constructs the consequences of law as essentially fixed by other people’s private choices, beyond the power and politics of the policy analyst and government, without consideration of how past and present and future rights or wrongs constrain or enable those choices.  In this neoclassical view, the job of law is narrowed to the technical task of measuring some imagined sum of these individual preferences shaped through rational microeconomic bargains that represent a middling stasis of existing values and resources, reached through tough tradeoffs that nonetheless promise to constantly bring us toward that glimmering goal of maximizing overall societal gain (“welfare”) from scarce resources.

Driesen reverses that frame by focusing on complex change over time as the main thing we can know with certainty.  In the economic dynamic vision, “law creates a temporally extended commitment to a better future.” (Driesen p. 52). Read More

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Facebook Privacy Dinosaur

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I have yet to see it “in the wild,” but media outlets are reporting that Facebook has created a Privacy Dinosaur—a little helper that checks in on users in real-time to help ensure that they understand who will see their update or post.   Whether you think of this as “visceral notice,” a privacy “nudge,” or “obscurity by design,” suffice it to say that this development will be of interest to many a privacy scholar.

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‘Cognitive Infiltration': the Dark Side of the Nudge

In their influential book Nudge: Improving Decisions About Health, Wealth, and Happiness, Richard Thaler and Cass Sunstein make the case that the government can and should leverage what it understands about behavioral psychology to “nudge” citizens toward healthier activities and outcomes.  One objection the authors acknowledge is that hacking people’s behavior, while not coercive in the classic sense, is still manipulative.  The authors anticipate this critique and respond by invoking the publicity principle from the work of John Rawls: officials should not nudge people in ways that would raise serious concerns were their methods made public.  “The government should respect the people whom it governs,” write Thaler and Sunstein, “and if adopts policies it could not defend in public, if fails to manifest that respect.”

The publicity principle is not an adequate response to the manipulation critique for a few reasons.  First, the response conflates what is publicly acceptable with what is democratically legitimate.  And second, because it calls for internal deliberation (“could not defend”) rather than actual transparency, the response assumes officials and the public will be on the same page about what methods are objectionable.  This turns out to be a questionable assumption.

I discuss these and other objections to nudging in my recent essay Code, Nudge, or Notice?  What I want to focus on here is the revelation this week that the British government is using psychology to influence and disrupt “hacktivist” and other online communities.  What was particularly astonishing (to me) was that Sunstein advocated for a version of this practice the very year Nudge hit the market.  Specifically, according to reporting by the indomitable Glenn Greenwald, Sunstein co-authored a 2008 memo suggesting the use of “cognitive infiltration” against “anti-government groups.”

I point this out not to demonstrate somehow that Sunstein is a hypocrite.  In addition to being rude and ad hominem, such an allegation finds little support.  I personally have tremendous respect for Sunstein as an intellectual and public servant.  Rather, I offer the example of cognitive infiltration—which, let us be clear, represents the sheep of libertarian paternalism in wolf’s clothing—as a vivid illustration of how a publicity principle falls short.  Some officials in the United States and Great Britain thought it would be just fine to manipulate citizens psychologically in an effort to disrupt inconvenient (if often misguided) ideologies.  Other individuals think the practice is, well, disrespectful.

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UCLA Law Review Vol. 61, Issue 3

Volume 61, Issue 3 (February 2014)
Articles

How to Feel Like a Woman, or Why Punishment Is a Drag Mary Anne Franks 566
Free: Accounting for the Costs of the Internet’s Most Popular Price Chris Jay Hoofnagle & Jan Whittington 606
The Case for Tailoring Patent Awards Based on Time-to-Market Benjamin N. Roin 672

 

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