Category: Behavioral Law and Economics

3

Bubble Warning on Facebook, Groupon

The mysterious ways of financial valuation manifest daily. One mystery: Facebook, the social network business, and Groupon, the buying network company, both generate annual revenues of about $1 billion. Yet reported private stock trading indicates that traders are pricing Facebook at about 50 times that while pricing Groupon at about 5 times that.

Perhaps this is attributable to analytical factors, such as observed user growth rates, potential market and revenue sources, perceived capacity to convert the revenue into earnings, competitive threats—or negotiating skill in trading of privately-held shares. But given the wildly varying pricing traders give enterprises like this in recent years, it could be a sign of a bubble.

Financial bubbles recur as a natural, inherent product of human behavior in capitalist economies—from the recent real estate bubble, to the dot-com bubble a decade earlier, and stretching back to the tronics bubble of the 70s and back to Amsterdam tulip bulbs centuries ago.  (I wrote a trade book about this after last decade’s bubble burst.)  By definition, a critical mass cannot recognize the bubble as it is in inflating, though invariably some pessimists detect something. Read More

4

Three Policy Interventions for Reducing Privacy Harms

Thanks so much to Danielle and Concurring Opinions for inviting me to blog. This is an exciting opportunity and I look forward to sharing my thoughts with you. Hopefully you will find these posts interesting.

There are many policy interventions that legislators can impose to reduce harms caused by one party to another. Two that are very often compared are safety regulations (mandated standards) and liability. They lend themselves well to comparison because they’re generally employed on either side of some harmful event (e.g. data breach or toxic spill): ex ante regulations are applied before the harm, and ex post liability is applied after the harm.

A third approach, one that we might consider ‘sitting between’ regulation and liability, is information disclosure (e.g. data breach disclosure (security breach notification) laws). I’d like to take a few paragraphs to compare these alternatives in regards to data breaches and privacy harms.

Three Interventions

 

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10

The Numbers are REALLY In–Plus Two Modest Proposals

For those of you who had any doubts, our friends at Kaplan have just confirmed it:  Aspiring law students care more about law school rankings than anything else, including the prospects of getting a job, quality of program, or geography.

Sayeth Kaplan:

1,383 aspiring lawyers who took the October LSAT . . . [were] asked “What is most important to you when picking a law school to apply to?” According to the results, 30% say that a law school’s ranking is the most critical factor, followed by geographic location at 24%; academic programming at 19%; and affordability at 12%. Only 8% of respondents consider a law school’s job placement statistics to be the most important factor. In a related question asking, “How important a factor is a law school’s ranking in determining where you will apply?” 86% say ranking is “very important” or “somewhat important” in their application decision-making.

Mystal at ATL expresses shock–shock!–that potential law students could be so naive. Surely, he fairly observes, they should care most about job prospects.

Yes, that would be true if they were rational.  Yet, we all know from the behavioral literature that we apply a heavy discount rate to long-distance prospects.  How much can I or  should I care today about what may happen 3 (or 4) years from today?

If you think about it from the perspective of any law school applicant today, the one concrete thing they can lock onto that has present value is the school’s ranking:  It is simple, quantified, and–perhaps most important–tauntable.  No one’s face burns with shame because their enemy (or friend)  got into a law school with a better job placement rate.  Jealously and envy–the daily diet of anxious first-years–are driven by much simpler signals:  Is mine bigger (higher) than yours?

This is not to defend the students who place so much faith in numbers that have repeatedly been shown to be incredibly stupid.  It just means that Kaplan’s survey (and I have not seen the instrument or data) makes intuitive sense.

Which leads to me to offer two modest (and probably unoriginal) proposals:

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4

CELS V: The Year of the Experiment

Data Collection Makes Everyone Grumpy and Hunched Over

For the last several years, I’ve posted recaps of the Annual Empirical Studies Conference.  (See me, @ Cornell, @ USC).  This year, as promised, will be no different.  Yale hosted CELS V, and the committee did a bang up job: the food was tasty; there were no technical snafus of note; and the panels appeared to have a high degree of internal validity & congruence. Richard Brooks, Alan Gerber, Dan Kahan, Yair Listokin, Tracey Meares, and (especially) Roberta Romano are all due a round of applause, or, better yet, supersized computer monitors so they can see their data better.  In this post, I’m going to provide a running diary of the conference.  It will be like you were there with me, except you don’t have to suffer through my bouts of social anxiety!

Unfortunately, I missed the hottest ticket of the conference, Bruce Ackerman’s commentary on Law/Versteeg’s The Evolution and Ideology of Global Constitutionalism.  From all reports, Ackerman said something like: “wrong questions, wrong data, wrong theory,” and then imploded in frustration.  Instead of watching those fireworks, I was watching Yair Listokin present The Meaning of Contractual Silence: A Field Experiment [Here’s an older version of the paper].  Listokin ran a field experiment selling ipods on ebay, some with a warranty, some as-is, and some silent on the warranty term. He found that individuals paid attention to the contract, and there was some evidence that the UCC default was about what they thought silence meant.  As he admitted, there were problems with the design of the study – particularly, (1) small & skewed samples; and (2) a lack of clarity about how much buyers know about ebay’s unique and self-contained dispute resolution system.  As someone remarked after the presentation, it would have been interesting had Listokin sold all the customers bad ipods (instead of good ones) and studied how the contract terms influenced behavior post-“breach”.  Then again, who needs that IRB hassle?

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0

Litigating Toward Settlement

What is the relationship between litigation and settlement?  In a new working paper, Christina Boyd and I explore that question using data from federal trial dockets.  Our basic intuition is that motion practice propels cases toward faster settlements, as it unlocks information about the facts, the parties’ strategies, the resources they will spend on the case, and (sometimes) what the judge thinks of the merits.  Our results essentially support such hypotheses: the mere filing of a motion speeds case settlement. Moreover, “motions which are granted are more immediately important to the settlement rate than motions denied, plaintiff victories are more important than defendant victories, motions about unclear areas of law are more important than motions about settled law, and motions later in cases are more important that motions earlier in cases.”  These findings are suggestive.  Though motion practice is often thought of as parasitic, driven by agency costs, and part the problem of litigation, our results imply that it has significant pro-social consequences.  Indeed, paying homage to Gilson, why not re-imagine lawyers as canny litigation costs engineers?

We also found some nifty case effects.  Women judges were on average (as Boyd had previously established) better at encouraging settlement than men: “the likelihood of a case settling in any given month is, on average, 25% larger when a female judge presides than when a male judge does.” Also, imbalance between the size of the firms representing the plaintiff and the defendant had a significant influence on compromise’s timing, as the figure below illustrates:

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5

When a (Health Care) Fine is a (Health Care Price): Israeli Day Cares and HCR

Fortune reports that during the health care debate, AT&T, Verizon, Caterpillar, and John Deere all  produced internal documents considering whether it made sense to stop providing health insurance and simply pay the fine:

AT&T produced a PowerPoint slide entitled “Medical Cost Versus No Coverage Penalty.” A document prepared for Verizon by consulting firm Hewitt Resources stated, “Even though the proposed assessments [on companies that do not provide health care] are material, they are modest when compared to the average cost of health care,” and that to avoid costs and regulations, “employers may consider exiting the health care market and send employees to the Exchanges.”  . . .

Kenneth Huhn, vice president of labor relations at Deere, said in an internal email that his company should look at the alternatives to providing health benefits, which “would amount to denying coverage and just paying the penalty,” and that he felt he already had the ability to make this change under his company’s labor agreement. Caterpillar felt it would have to give “serious consideration” to the penalty option.

You might see these documents as posturing, whimsical make-work*, or simply good business planning.   But I tend to think about this as an example of the Israeli day care problem: when you put prices on conduct that previously was enforced through social norms, you may increase its incidence.** This phenomenon, incidentally, would appear to be even more important when considering how to enforce the individual mandate .

*The whimsy story is supported by the unwillingness of the firms to stand behind their analysis today.

**Of course, you might object that employer-provided health insurance results from market incentives, not social practice, but I’m not so sure those concepts are easily segregated.

10

Endowment Effects, Confirmation Bias, and the Politics of Health Care Post-Passage

Gavel of Justice, or Hammer of Doom. Your Call. (Chip Somodevilla / Getty Images / March 21, 2010)

Sen. Tom Harkin articulates the new conventional wisdom:

“I can’t wait for this debate [about Health Care reconciliation and repeal] to happen. I look forward to it. I will relish it,” Harkin said, on his way into a weekly Democratic caucus lunch. “Now the bill is passed, its signed into law. Now the American people have something. They own it. It’s theirs. And the Republicans are saying they want to take it away from them.”

This sounds like an argument based on the endowment effect. But it’s actually not all that clear that this “bias” operates in the way that Sen. Harkin posits, i.e., that individuals will value the benefits of a law more after it passes, because they exhibit loss aversion.  This optimism risks ignoring an important limitation on endowment, which (simplifying radically) suggests that how you obtain property seriously affects whether you exhibit an endowment superpreference.  That is: when people think that property is allocated randomly or by grace, they value it less than when they feel they’ve earned it.  It strikes me that Republicans will have every incentive to try to convince the public that health care goods have been allocated randomly or by influence peddling, rather than because the Congress deliberated fairly and divided by desert.  That’s why fighting about reconciliation and in the courts make strategic sense: not because such battles are likely to succeed (they aren’t) but because they reduce general belief in the procedural legitimacy of reform and attachment to its substantive products.

In other news, Prof. Ann Althouse is very defensive about saying “so what if some idiot said a bad word,” referring to the worst word there is.  Of course, what was objectionable was that she first asserted – with no evidence at all – that Representative Lewis had made up the charge  (“It’s one of the oldest dirty tricks.)  Then, she argued that it was actually white politicians who were upset by the protesters who were racist because they were “so quick to think of powerful black politicians as vulnerable and besieged.”  All this while refusing to permit her commentators to actually use the word, presumably because she recognizes that it is uniquely stigmatizing, evil, and, well, racist.

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1

Milgram on T.V.

At least Milgram Wasn't Doing It For Profit

From the hyper-civilized French comes a new game show:

Game show contestants turn torturers in a new psychological experiment for French television, zapping a man with electricity until he cries for mercy — then zapping him again until he seems to drop dead.

“The Game of Death” has all the trappings of a traditional television quiz show, with a roaring crowd and a glamorous and well-known hostess urging the players on under gaudy studio lights.

But the contestants did not know they were taking part in an experiment to find out whether television could push them to outrageous lengths, and which has prompted comparisons with the atrocities of Nazi Germany.

The better analogy is Stanley Milgram’s Yale experiments, which were the direct inspiration for this show.  Though the article blames television’s “absolutely terrifying power” to compel obedience here, I think the result can be explained much more simply as depending on the power of authority itself.

Maybe we need an IRB for reality show producers.

4

Contracting (or Arbitrating) Out of Medical Malpractice Liability

Jennifer Arlen came to Temple on Monday to workshop her paper, Contracting Over Malpractice Liability, forthcoming in the Penn Law Review.  I was her commentator.  Prof. Arlen uses fairly traditional economic analysis, assuming that patients are rational, to argue that it not welfare maximizing to permit patients to contract out of the background medical malpractice regime.

The argument is fairly easily to follow. She argues that tort liability, because it is prospective and systemic, motivates providers to invest in precautions that are general and non-rivalrous: a collective good.  Thus, medical safety investments will be underproduced if left to the incentives of individual contracting parties, since each patient will want to free-ride off others’ choices to purchase “liability” from their doctors.  Moving liability to managed care organizations doesn’t help matters, it turns out, because it would simply permit the company to segregate between consumers who need liability protection (ones who are, or are likely to become, sick) and those who don’t (the young and healthy).  Under such a system, MCOs will package “good” health insurance together with liability, meaning that healthy individuals with a taste for liability coverage will need to pay a premium to access it.  This again leads to insufficient amount of liability protection over all patients.

It’s an important paper, not least because the form of argument may generalize to other kinds of contracting over private law.  Isn’t it true for most forms of negligence protection that the benefits are non-rivalrous and hard to exclude?  If so, permitting any contracting out of tort law likely results in a net loss of socially optimal deterrence.  Similarly, contracting out of civil procedure may lead to loss in societal benefits (like, for example, the litigation-generated-spillovers resulting from more information about the content and operation of legal rules.)  That said, as I commented to Prof. Arlen, it’s not clear whether she really maintains that patients are rational maximizers, since some of the argument relies on facts about the world (e.g., bad monitoring by insurance companies, insufficient lawsuits) that are difficult to square with rational choice theory. Also, what does medical error mean anyway?

I thought it would be worthwhile to bring this paper to your attention, since we’re living in a world where contract law’s dominance over torts is becoming ever more evident.  As this law firm circular points out, doctors are requiring patients to sign enforceable arbitration clauses.  It’s my sense that the bleak view that Arlen’s paper gives of contracting out of liability entirely also extends to such agreements.

*Whether they are a true public good or rather a club good is a little bit obscure in the paper.

1

Spurning Free Kisses and the Iron Laws of Behavioral Psychology

Even Tastier When They're Free

In Free, The Future of a Radical Price, Chris Anderson leverages a few behavioral psychology experiments to assert that companies ought to embrace free distribution as a business model.  In particular, he highlight’s Dan Ariely’s work with Hershey kisses.  As Malcolm Gladwell explained Arielly’s work in his review of Free:

Ariely offered a group of subjects a choice between two kinds of chocolate—Hershey’s Kisses, for one cent, and Lindt truffles, for fifteen cents. Three-quarters of the subjects chose the truffles. Then he redid the experiment, reducing the price of both chocolates by one cent. The Kisses were now free. What happened? The order of preference was reversed. Sixty-nine per cent of the subjects chose the Kisses. The price difference between the two chocolates was exactly the same, but that magic word “free” has the power to create a consumer stampede.

On this narrow reed Anderson concludes that free goods create extraordinary psychic effects.  Both Gladwell and Matt Yglesias, otherwise quite critical of Anderson, embrace the point.  Ygelesias argues that companies will compete away any behavioral effects, and that costs will never actually get to zero.  He observes that, “the whole subject could stand to benefit from a little less good writing and a bit more plodding distinction-drawing.”

Well, I think I am well qualified to be a worse writer than Malcolm Gladwell, so I’ll try plodding for a bit.  To begin with, folks should read the paper.  It offers a readable description of the experimental series.  Or, if you’ve a copy of Ariely’ book, he apparently synopsizes the results.  After you’ve read the paper, return here for three quick questions about the general applicability of Ariely’s work:

First, we don’t know whether those effects are robust.  Even if companies aren’t well-situated to compete away the “free” bonus, is it a universal attribute of human cognition, or something contingent and culturally fleeting?  My sense is that the modern economy makes it much harder for ordinary consumers to know the worth/value of goods.  (I bet this is testable: have people gotten worse, as I’d guess, at the “Final Showcase” estimates at the Price is Right over time?)

Second, will the result will hold up against debiasing?  Most of the studies conducted involved relatively quick decisions in an noisy environment (a school cafeteria).  Would you get the same result if you told people about the “free effect” before exposing them to the choice? I tend to think not — doesn’t engaging in this kind of behavior make the subject into a bit of a sucker?

Third, what about heterogeneity? Ariely doesn’t tell us much about individuals who continued to prefer truffles.  Are the different demographically from the switching individuals?  There’s a very strong nomothetic theme in Ariely’s work (like most BLE work).  But not all individuals fall prey to the pull of free goods.  Maybe we ought to study those who don’t want kisses, before we reform our marketing (and our law) to exploit (or protect) those that do.