Before returning to the legal boundaries of monetary policy, I wanted to briefly highlight some interesting contract and regulatory issues lurking just beneath the surface of an unusual Kansas state court order declaring a sperm donor to be the legal father of a child, against the wishes of all persons involved.
In 2009, a Topeka man answered a Craigslist ad soliciting sperm donations. The ad was placed by a lesbian couple, Jennifer Schreiner and Angela Bauer. The man supplied a donation. Schreiner became pregnant and delivered a baby. Schreiner began receiving Kansas welfare benefits for the child. Seeking child support payments, the state sued the sperm donor to establish paternity. The state argued that the donor—who lacks any relationship with the child or the couple (now estranged) beyond supplying the donation—was the child’s legal father, and therefore must pay child support.
This is where the case gets interesting as a matter of private ordering and trade regulation.
Prior to the donation, all persons involved—the donor and both members of the couple—signed a non-paternity agreement in which the donor waived his parental rights and was released from his parental obligations.
Both mothers opposed the state’s campaign to declare the donor the child's legal father.
Nevertheless, the court granted the state’s paternity petition, which means it can now seek to compel the donor to provide child support. The paternity finding also appears to give the donor a good shot at asserting parental rights (though he seems unlikely to try).
Justifying its decision to ignore the wishes of both parents and the donor, the court intoned:
A parent may not terminate parental rights by contract, however, even when the parties have consented.
Well, maybe this case is a morality tale about those who would seek a father for their child on Craigslist. A warning from a heartland state to those who would selfishly try to contract around their sacred parental obligations. A sign that courts place the welfare of the child above all else. Right?
Haha, of course not!
Kansas law makes it easy to conclusively terminate the parental rights and obligations of sperm donors by contract. Care to guess what you need to do, besides sign a contract?
Pay a doctor.
The court explained:
Through K.S.A. 23-2208(f) [PDF], the Kansas legislature has afforded a woman a statutory vehicle for obtaining semen for [artificial insemination] in a manner that protects her and her child from a later claim of paternity by the donor. Similarly, the legislature has provided a man with a statutory vehicle for donating semen to a woman in a manner that precludes later liability for child support. The limitation on the application of these statutory vehicles, however, is that the semen must be “provided to a licensed physician." [FN1] (emphasis added)
The parties failed to do this.
So, the upshot is that you are free to find a father for your child on Craigslist—and you can even count on the State of Kansas to keep him out of your child’s life in the future—so long as you hire a doctor to do the procedure. Similarly, you can spend your free time fathering children on Craigslist without losing sleep over child support suits—as long as you kick some of the action upstairs to an M.D.
It’s not just Kansas; California, Illinois, and as many as 10 other states [FN2] follow the same law, the Uniform Parentage Act of 1973.
I’m not a family law expert, but it seems to me that a complete list of legitimate and unique public policy concerns that are implicated when a couple and a third-party sperm donor settle their parental obligations by contract looks something like this:
- Ensuring that the state can identify who can be held legally responsible for supporting the child.
Nevertheless, let’s assume there are also truly compelling public health reasons to involve a physician in artificial insemination. After speaking with a few doctors, I’m skeptical that this is the case, but even if it were here are ten points that I think are worth considering:
- Should a mother who became pregnant by artificial insemination be forced to share parental rights with a stranger who donated sperm simply because she decided not to hire a doctor for the procedure?
- Conversely, should the scope of a sperm donor’s rights and responsibilities as a father turn on the decision whether to enlist a doctor to oversee the procedure?
- Should the adequacy of a child support scheme turn on whether couples using sperm donors choose to hire a doctor?
- There are sound public policy reasons to be concerned about voluntariness in agreements that waive paternity. But if this case is really about ensuring voluntariness, why is enlisting doctors the solution? Establishing consent during contract formation is not some novel problem. Hiring a doctor is a novel solution, but as an evidentiary device it is not very probative.
- Hiring doctors for artificial insemination is not cheap. A single attempt through a physician’s office costs about $3,000, and sometimes multiple attempts are necessary. Unsurprisingly, the American Fertility Association (a trade group for the fertility industry) applauded the court’s decision.
- This rule looks even more like an attempt to extract rents when you consider that for many people, the price of artificial insemination without physician assistance may be zero.
- If the state interest in the use of doctor-assisted artificial insemination is so compelling, maybe the law should simply require it on penalty of criminal sanction. I have never even heard this idea floated, probably because it would be perceived (rightly) as an excessive intrusion on various important freedoms…
- …yet while they do not provide criminal sanctions, about 13 states are willing to provide unbelievably harsh "family-law sanctions." If a woman declines to hire a doctor, she is placing herself and her child in eternal jeopardy; at any time, the donor or the state can move to declare the donor to be the legal father, which would put the donor in a position to seek full parental rights—even if he is a stranger. (The same is true in reverse re: child support.) It is unsurprising that both mothers opposed the state’s petition.
- Although facially neutral, this rule is almost certainly discriminatory in practice. It means that lesbian couples must either hire a doctor or adopt—there is no other way they can safely preclude the donor from being granted parental rights. And of course this is just one of many unofficial taxes gays and lesbians must pay, especially in states like Kansas that do not allow them to marry. It seems to me that there’s a good argument the law should fail rational basis or equal protection review, but I will leave that brief to the con law scholars.
- Finally, beyond any constitutional infirmity, this law should serve as a reminder that protectionist regulations—which often take the form of onerous occupational licensing restrictions and NIMBY zoning rules—frequently have regressive distributional consequences, because they tend to favor powerful incumbents. And although probably not the case here, such laws can harm the broader economy as well by stifling innovation.
I welcome your comments. And I hope my doctor friends still talk to me.
* * * *
[FN1] It should be noted that under the letter of the statute as well as a 2007 Kansas Supreme Court decision (PDF) on this issue, the court did not have an obvious alternative to finding for the state. The problem, such as there is one, is with the statute.
[FN2] An accurate count is not possible without doing a full 50-state survey. As I have written about previously, the Uniform Law Commission’s Enactment Status Maps are often unreliable or imprecise (see FNs 163 & 188).
Greetings, Glommers! (and hello, Janet and Mario*!)
It’s an honor to join this extremely sharp and thoughtful community of corporate and commercial law scholars for the next two weeks. The Conglomerate has long been one of my favorite law blogs and it’s truly a privilege to walk among these folks for a time (if a bit daunting to follow not just them but Urska Velikonja and her excellent guest posts). Thanks to Gordon, David, and their Glom partners for inviting me to contribute.
By way of biographical introduction, I’m currently a Visiting Assistant Professor at the University of Denver Sturm College of Law, where I teach International Business Transactions and International Commercial Arbitration. Last year, I did a VAP at Hofstra Law School (and taught Bus Orgs and Contracts).
In the next few weeks, I’ll be exploring a number of issues related to law and global finance. I have a particular interest in currencies and monetary law, or the law governing monetary policy. Two of my current projects (on which more soon) address legal aspects of critical macroeconomic policy questions that have emerged since 2008: U.S. monetary policy and the Eurozone sovereign debt crisis.
Without further ado, I will take a page from Urska and kick off my residency here with a somewhat meta question: should scholars refrain from writing about legal issues in macroeconomics, specifically monetary policy?
One thinks of monetary policy decisions—whether or not to raise interest rates, purchase billions of dollars of securities on the secondary market ("quantitative easing"), devalue or change a currency—as fundamentally driven by political and economic factors, not law. And of course they are. But the law has a lot to say about them and their consequences, and legal scholarship has been pretty quiet on this.
Some concrete examples of the types of questions I’m talking about would be:
- Pursuant to its dual mandate (to maintain price stability and full employment), what kinds of measures can the Federal Reserve legally undertake for the purpose of promoting full employment? More generally, what are the Fed’s legal constraints?
- What recognition should American courts extend to an attempt by a departing Eurozone member state to redenominate its sovereign debt into a new currency?
When it comes to issues like these, it is probably even more true than usual that law defines the boundaries of policy. Legal constraints in the context of U.S. monetary policy appear fairly robust even in times of crisis. For example, policymakers themselves often cite law as a major constraint when speaking of the tools available to the Federal Reserve in combating unemployment and deflation post-2008. Leading economics commentators do too. Yet commentary on “Fed law” is grossly underdeveloped. With the exception of a handful of impressive works (e.g., by Colleen Baker and Peter Conti-Brown), legal academics have largely left commentary on the Fed and macroeconomics to the econ crowd.
A different sort of abstention characterizes legal scholarship on the euro crisis. Unlike the question of Fed power, there is a burgeoning literature on various “what-if” euro break-up scenarios. But this writing tends to focus on the impact on individual debtors and creditors, not on the cumulative impact on the global financial system. Again, the macro element is missing.
It is curious that so many legal scholars would voluntarily absent themselves from monetary policy debates. The subtext is that monetary policy questions are either normatively or descriptively beyond the realm of law. If that is scholars’ actual view, I think it is misguided. But maybe the silence is not as revealing as all that.
- One issue is sources. You will not find a lot of useful caselaw on the Fed’s mandate or the Federal Reserve Act of 1913, and the relevant statutes and regulations are not very illuminating. Further, it’s a secretive institution and that makes any research (legal or otherwise) on its inner workings challenging.
- Another issue is focus. Arguably the natural home of legal scholarship on domestic monetary issues, for example, should be administrative law. But the admin scholarly gestalt is not generally as econ-centric as, say, securities law. Meanwhile, securities scholars tend to focus on microeconomic issues like management-shareholder dynamics.
- A final possibility, at least in the international realm, is historical. After World War II, Bretton Woods established a legal framework intended to minimize the chance that monetary policy would again be used as a weapon of war. The Bretton Woods system collapsed over forty years ago, the giants of international monetary law (Frederick Mann, Arthur Nussbaum) wrote (and died) during the twentieth century, and now even some of the leading scholars who followed in their footsteps have passed away. At the same time, capital now flows freely across borders and global financial regulation has become less legalized in general. These factors plus the decline of exchange-rate regulations (most countries let their currencies float) may have undermined scholars’ interest in monetary law. But as the ongoing euro saga demonstrates, international monetary law and institutions remain as critical as ever.
These are some possible explanations for why legal scholars have largely neglected questions of monetary law, but I’m sure I’ve overlooked others. What do you think?
*Pictured are Janet Yellen and Mario Draghi, chiefs, respectively, of the Federal Reserve and the European Central Bank.
Permalink | Administrative Law| Comparative Law| Economics| European Union| Finance| Financial Crisis| Financial Institutions| Globalization/Trade| Law & Economics| Legal Scholarship | Comments (5) | TrackBack (0) | Bookmark
Ronald Coase had some ideas about why speech is given more protection from government intervention than economic activity:
The paradox is that government intervention which is so harmful in the one sphere [speech] becomes beneficial in the other [economics activity].... What is the explanation for the paradox? ... The market for ideas is the market in which the intellectual conducts his trade. The explanation of the paradox is self-interest and self-esteem. Self-esteem leads the intellectuals to magnify the importance of their own market. That others should be regulated seems natural, particularly as many of the intellectuals see themselves as doing the regulating. But self-interest combines with self-esteem to ensure that, while others are regulated, regulation should not apply to them. And so it is possible to live with these contradictory views about the role of government in these two markets. It is the conclusion that matters. It may not be a nice explanation, but I can think of no other for this strange situation.
Ronald H. Coase, The Economics of the First Amendment: The Market for Goods and the Market for Ideas, 64 AM. ECON. REV. PROC. 384, 386 (1974).
There are some powerful counters to this argument (e.g., speech is a public good that is likely to be underproduced, especially if not protected vigorously), but I just thought it was interesting that Coase had written this article on the First Amendment.
After over four years of work, my book Law, Bubbles, and Financial Regulation came out at the end of 2013. You can read a longer description of the book at the Harvard Corporate Governance blog. Blurbs from Liaquat Ahamed, Michael Barr, Margaret Blair, Frank Partnoy, and Nouriel Roubini are on the Routledge’s web site and the book's Amazon page. The introductory chapter is available for free on ssrn.
Look for a Conglomerate book club on the book on the first week of February!
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Dan Doctoroff is giving $5 million to the law school in Hyde Park to develop a law and business curriculum, which isn't exactly a vast amount of money, but congratulations to UC nonetheless. Like Wharton, Chicago has a 5-years-in-4 MBA-JD program already; there is a lot of happiness about the program in these parts, but it does require students to pay a ton of tuition, and compresses their schedule flexibility massively. It sounds the Doctoroff donation will permit law students to take classes at Booth, or maybe buy out some Booth teachers to teach a class exclusively comprised of law students on asset valuation, managerial economics, and &c.
One bridge that must be crossed for such classes concerns the basic level of knowledge of the law students. Some Wharton students are coming from the army or Teach For America, but most have been spending a few years working on spreadsheets and going through quarterly statements. This sort of thing provides a critical background (and a culture spreadable to those who are abandoning their careers in ballet or publishing) that just being smart and eager does not, and my case study for that would be the accounting for lawyers classes you might have taken in law school, and promptly forgot about. Good luck to Chicago as it seeks to deliver classes that law students can find instructive; oddly enough, it might be easier to focus on undergraduate finance offerings rather than on the MBA program.
Here is my disclaimer: I'm from "tornado alley." Here is "my tornado." The Lubbock tornado was 43 years ago (gulp), when I was an infant. I have no memories of it, just the story that my parents told me. We went down the street to a neighbor's storm cellar; the tornado didn't come that close to our neighborhood; we left the dog in our kitchen.
This week, as the history of the Moore, Oklahoma tornado is being written, I have read articles and heard radio stories asking why more residents in tornado-prone areas don't have storm cellars or safe rooms in their houses, schools, etc. Not only why don't residents take more precautions, but why doesn't the law require new houses have tornado protection (similar to earthquake building requirements).
I never had a basement until I moved out of Texas to the Midwest. In West Texas, and it seems Oklahoma and maybe further north, basements aren't really necessary. Land is flat and available. If you want more square footage, building out is cheaper than digging a basement in the really, really hard soil. I remember having two friends my entire childhood that had basements, and everyone was really, really jealous of them (mostly because there seemed to be a lot more kissing in basements than in main floor family rooms). Basements would also be handy in the case of a tornado, but are rare. Instead of digging a basement, the law could require a separate storm cellar in a backyard or attached. The NYT article estimated this cost as $4k, which seems like a low estimate to me. So, is adding $4k to every newly constructed home prohibitive? Is it wise?
The problem is that everyone doesn't need their own cellar, and most people will never need one. If you think of all the homes that are situated in tornado alley, the probability of a particular home needing a cellar is really, really low. And the cellar doesn't save your house. It saves you, if you happen to be at your house. At least in the Lubbock tornado, many victims were in cars, or fleeing their cars. (Here are some pretty interesting tornado data.) The reporters seen to think the probability of needing a cellar is really high in Moore, which also had a tornado in 1999 (no fatalities, but property damage). In a perfect world, there would be one storm cellar, safe room or basement per block, not per house. That's pretty hard to regulate. But, having a storm cellar or safe room per school or office building doesn't seem like a bad idea. (I haven't heard anyone talk about mobile homes/trailer homes, which are even less stable than a home with a shallow foundation.)
Interestingly, this same week, commentators in the news have questioned Angelina Jolie's choice to have genetic testing for breast cancer (that costs $3-4k, a little less than a storm shelter), then have a double mastectomy when she learned a rare gene gave her probability of getting breast cancer was 87%. Well, no one in tornado alley has an 87% chance of dying in a tornado.
The other variable, besides the probability that a tornado will hit not only your town, but your block, is whether you would go into the storm cellar. Here, the NYT article and the NPR story seemed to suggest that there is a low level of panic for residents of tornado alley. That may be true. The summers of my childhood seemed to be filled with tornado warnings and tornado watches, which we soon began to ignore. These warnings would shoot across our broadcast TV channels, and some families had storm radios in case the electricity went off. But, after awhile, you get a little desensitized to the daily tornado warning. And, of course, there are stormchasers, a category of thrill-seekers that I still don't understand. But even non-stormchasers can be mesmerized on their way to the cellar watching the sky, which looks really awesome in the middle of a storm.
But I guess what bothers me about these "why don't you have a cellar" questions is an underlying sense that people in tornado alley are stupid, so we should regulate their housing. I disagree.
One of my colleagues said that my latest article (written with one of my excellent students, Jordan Lee) sounds like an R-rated movie. The title is Discretion, and here is the abstract:
Discretion is an important feature of all contractual relationships. In this Article, we rely on incomplete contract theory to motivate our study of discretion, with particular attention to fiduciary relationships. We make two contributions to the substantial literature on fiduciary law. First, we describe the role of fiduciary law as “boundary enforcement,” and we urge courts to honor the appropriate exercise of discretion by fiduciaries, even when the beneficiary or the judge might perceive a preferable action after the fact. Second, we answer the question, how should a court define the boundaries of fiduciary discretion? We observe that courts often define these boundaries by reference to industry customs and social norms. We also defend this as the most sensible and coherent approach to boundary enforcement.
I wrote an article about a decade ago called "The Critical Resource Theory of Fiduciary Duty" that still gets downloaded and cited a fair amount, at least for a fiduciary duty article. It is about the structure of fiduciary relationships, and I wanted to do a follow on article about how courts know when someone has breached a fiduciary duty. I actually had a fairly long draft of an article that was just horrible, and I never published it, but I kept thinking about and teaching about this problem. Earlier this year, I had a brainstorm about the subject, and the result is this new article.
By the way, interest in fiduciary law seems to have exploded in the past decade. Some of that interest stems from Tamar Frankel's book and the accompanying conference at Boston University. Some of the interest stems from the fact that fiduciary law is interesting in many countries outside the United States, where much of the best writing on this subject is found (see Paul Miller, for example). I look forward to a new surge in interest this summer, as Andrew Gold and Paul Miller have organized an excellent conference on The Philosophical Foundations of Fiduciary Law, to be held in Chicago. I am writing a paper entitled "True Loyalty" for that conference and very much looking forward to reading the other contributions.
Here are a few gift suggestions culled from books published this year if your special someone is a lawyer who associates Modigliani and Miller with capital structure and not paintings with elongated faces and the Tropic of Cancer:
- Tamar Frankel’s The Ponzi Scheme Puzzle;
- Steve Bainbridge’s Corporate Governance after the Financial Crisis (for a point of comparison, see his former colleague Lynn Stout’s The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public);
- Research Handbook on the Economics of Corporate Law, a collection edited by Claire Hill & Brett McDonnell.
Even the non-lawyers and non-academics in your life might enjoy Frank Partnoy’s Wait: The Art and Science of Delay. Of course, the target audience might never get around to buying the book.
Our local newspaper had a front-page story yesterday highlighting the fact that in a number of recent bank robberies (yes, they still rob banks here), the security photos were so blurry and grainy that they were simply useless. In fact, one bank still used a system that shot only black and white photos. Why would banks have less photographic technology than your cell phone? The article went on to describe state-of-the-art systems a bank might want to install from $2,000 to $14,000. My first thought was "Why wouldn't a bank install a $10k security system?" And my second thought was "Why would a bank spend $10k on a security sytem?"
The answer to these questions would depend on the difference between the costs to the bank of a "cleared" bank robbery versus an "uncleared bank robbery. Banks obviously have an interest in deterring bank robberies and avoiding employee and/or customer victimization and trauma, violence, and loss of customers. But once the robbery takes place, does it matter to the bank if the robber is caught?
I found a DOJ report on bank robbery, although it's a few years old. From this report, I learned that in 80% of robberies, the money is never recovered, and that 20% number includes robbers who are apprehended on the spot. So, once the robber is out the door, the chances of avoiding a loss is pretty low, even if your photo is incredibly clear. Also, most bank robbers get caught anyway -- 1/3 in 24 hours, and 1/2 in a month. If not caught quickly, the chances of the robber being caught rapidly diminish, probably reflecting the difference between amateur robbers and professional robbers. So, if you are a small-town bank, you may not feel that investing a lot of money in security cameras when the amateur robber will probably be caught anyway, and then even empty-handed. If you are a big, national bank with a presence in urban centers that might be attractive to professionals, then you might want to be on the forefront of security.
Also, the average robber gets away with $4000, and most banks have a 50% chance of being robbed over 10 years. So, the probable costs of the robbery, disocunted over time, may just not add up, even if you thought you could recover the $4000. Other costs to the bank, trauma therapy, employee time off, etc., would not be recoverable anyway.
But, do security cameras deter thieves? According to the DOJ report, no. Professionals wear disguises or disable cameras. Amateurs don't seem to figure them into the calculation. There are other ways to try to deter theft or minimize it, but some of them are expensive (security guards) or put off customers ("bandit barriers"). It may be that some banks just consider the occasional robbery as a cost of doing business.
Finally, bank robberies are not covered by FDIC insurance, but are covered by private insurance. Unless the insurer gives discounts or requires additional security measures, similar to smoke detectors or sprinkler systems, then the bank's incentives are even smaller.
But what about convenience stores? According to our newspaper, these stores have state-of-the-art equipment. Are convenience store owners' incentives different? First, 6% of robberies occur at convenience store, as compared to 2% at banks. Independent stores may not be as well-insured and so may more directly bear the costs of robberies. Also, convenience stores who are robbed have a greater chance of being robbed again if the robber isn't caught. In addition, these cameras work better because they have to cover smaller areas and are usually well-positioned.
Here is a highly productive way for business law professors to procrastinate from grading exams:
The National Bureau of Economic Research just circulated a new version of a paper that provides a medieval complement to the law & finance literature and to Gilson's lawyer as transaction cost engineer idea. The paper by Davide Cantoni and Noam Yuchtman presents evidence that the training of commercial lawyers by new universities contributed to the expansion of economic activity in medieval Germany. Here is the abstract:
We present new data documenting medieval Europe's "Commercial Revolution'' using information on the establishment of markets in Germany. We use these data to test whether medieval universities played a causal role in expanding economic activity, examining the foundation of Germany's first universities after 1386 following the Papal Schism. We find that the trend rate of market establishment breaks upward in 1386 and that this break is greatest where the distance to a university shrank most. There is no differential pre-1386 trend associated with the reduction in distance to a university, and there is no break in trend in 1386 where university proximity did not change. These results are not affected by excluding cities close to universities or cities belonging to territories that included universities. Universities provided training in newly-rediscovered Roman and Canon law; students with legal training served in positions that reduced the uncertainty of trade in medieval Europe. We argue that training in the law, and the consequent development of legal and administrative institutions, was an important channel linking universities and greater economic activity.
A very interesting read.
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The 2011 symposium edition of the Berkeley Business Law Journal on Dodd-Frank is out. I would like to thank the editors and the Berkeley Center for Law, Business and the Economy for inviting me to a great conference. My contribution, Credit Derivatives, Leverage, and Financial Regulation’s Missing Macroeconomic Dimension is now up on ssrn. Here is the abstract:
Of all OTC derivatives, credit derivatives pose particular concerns because of their ability to generate leverage that can increase liquidity - or the effective money supply - throughout the financial system. Credit derivatives and the leverage they create thus do much more than increase the fragility of financial institutions and increase counterparty risk. By increasing leverage and liquidity, credit derivatives can fuel rises in asset prices and even asset price bubbles. Rising asset prices can then mask mistakes in the pricing of credit derivatives and in assessments of overall leverage in the financial system. Furthermore, the use of credit derivatives by financial institutions can contribute to a cycle of leveraging and deleveraging in the economy.
This Article argues for viewing many of the policy responses to credit derivatives, such as requirements that these derivatives be exchange traded, centrally cleared, or otherwise subject to collateral or 'margin' requirements, in a second, macroeconomic dimension. These rules have the potential to change – or at least better measure – the amount of liquidity and the supply of credit in financial markets and in the 'real' economy. By examining credit derivatives, this Article illustrates the need to see a wide array of financial regulations in a macroeconomic context.
Understanding credit derivatives’ macroeconomic effects has implications for macroprudential regulatory design. First, regulations that address financial institution leverage offer central bankers new tools to dampen inflation in asset markets and to fight potential asset price bubbles. Second, even if these regulations are not used primarily as monetary or macroeconomic levers, changes in these regulations, including changes in the effectiveness of these regulations due to regulatory arbitrage, can have profound macroeconomic effects. Third, the macroeconomic dimension of credit derivative regulation and other financial regulation argues for greater coordination between prudential regulation and macroeconomic policy.
Comments by e-mail are always welcome.
Time Magazine’s “person of the year” is the “protestor.” Occupy Wall Street’s participants have generated discussion unprecedented in recent years about the role of corporations and their executives in society. The movement has influenced workers and unemployed alike around the world and has clearly shaped the political debate.
But how does a corporation really act? Doesn’t it act through its people? And do those people behave like the members of the homo economicus species acting rationally, selfishly for their greatest material advantage and without consideration about morality, ethics or other people? If so, can a corporation really have a conscience?
In her book Cultivating Conscience: How Good Laws Make Good People, Lynn Stout, a corporate and securities professor at UCLA School of Law argues that the homo economicus model does a poor job of predicting behavior within corporations. Stout takes aim at Oliver Wendell Holmes’ theory of the “bad man” (which forms the basis of homo economicus), Hobbes’ approach in Leviathan, John Stuart Mill’s theory of political economy, and those judges, law professors, regulators and policymakers who focus solely on the law and economics theory that material incentives are the only things that matter.
Citing hundreds of sociological studies that have been replicated around the world over the past fifty years, evolutionary biology, and experimental gaming theory, she concludes that people do not generally behave like the “rational maximizers” that ecomonic theory would predict. In fact other than the 1-3% of the population who are psychopaths, people are “prosocial, ” meaning that they sacrifice to follow ethical rules, or to help or avoid harming others (although interestingly in student studies, economics majors tended to be less prosocial than others).
She recommends a three-factor model for judges, regulators and legislators who want to shape human behavior:
“Unselfish prosocial behavior toward strangers, including unselfish compliance with legal and ethical rules, is triggered by social context, including especially:
(1) instructions from authority
(2) beliefs about others’ prosocial behavior; and
(3) the magnitude of the benefits to others.
Prosocial behavior declines, however, as the personal cost of acting prosocially increases.”
While she focuses on tort, contract and criminal law, her model and criticisms of the homo economicus model may be particularly helpful in the context of understanding corporate behavior. Corporations clearly influence how their people act. Professor Pamela Bucy, for example, argues that government should only be able to convict a corporation if it proves that the corporate ethos encouraged agents of the corporation to commit the criminal act. That corporate ethos results from individuals working together toward corporate goals.
Stout observes that an entire generation of business and political leaders has been taught that people only respond to material incentives, which leads to poor planning that can have devastating results by steering naturally prosocial people to toward unethical or illegal behavior. She warns against “rais[ing] the cost of conscience,” stating that “if we want people to be good, we must not tempt them to be bad.”
In her forthcoming article “Killing Conscience: The Unintended Behavioral Consequences of ‘Pay for Performance,’” she applies behavioral science to incentive based-pay. She points to the savings and loans crisis of the 80's, the recent teacher cheating scandals on standardized tests, Enron, Worldcom, the 2008 credit crisis, which stemmed in part from performance-based bonuses that tempted brokers to approve risky loans, and Bear Sterns and AIG executives who bet on risky derivatives. She disagrees with those who say that that those incentive plans were poorly designed, arguing instead that excessive reliance on even well designed ex-ante incentive plans can “snuff out” or suppress conscience and create “psycopathogenic” environments, and has done so as evidenced by “a disturbing outbreak of executive-driven corporate frauds, scandals and failures.” She further notes that the pay for performance movement has produced less than stellar improvement in the performance and profitability of most US companies.
She advocates instead for trust-based” compensation arrangements, which take into account the parties’ capacity for prosocial behavior rather than leading employees to believe that the employer rewards selfish behavior. This is especially true if that reward tempts employees to engage in fraudulent or opportunistic behavior if that is the only way to realistically achieve the performance metric.
Applying her three factor model looks like this: Does the company’s messaging tell employees that it doesn’t care about ethics? Is it rewarding other people to act in the same way? And is it signaling that there is nothing wrong with unethical behavior or that there are no victims? This theory fits in nicely with the Bucy corporate ethos paradigm described above.
Stout proposes modest, nonmaterial rewards such as greater job responsibilities, public recognition, and more reasonable cash awards based upon subjective, ex post evaluations on the employee’s performance, and cites studies indicating that most employees thrive and are more creative in environments that don’t focus on ex ante monetary incentives. She yearns for the pre 162(m) days when the tax code didn’t require corporations to tie executive pay over one million dollars to performance metrics.
Stout’s application of these behavioral science theories provide guidance that lawmakers and others may want to consider as they look at legislation to prevent or at least mitigate the next corporate scandal. She also provides food for thought for those in corporate America who want to change the dynamics and trust factors within their organizations, and by extension their employee base, shareholders and the general population.
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In the wake of the recent financial crisis, I’ve been pondering the role of courts in the formation and execution of corporate financial law and policy. My focus quickly shifts to a predicate question: How do courts currently handle controversies relating to complex corporate financial arrangements? And what can we learn from judicial action and inaction in this realm?
My Article, Confronting the Certainty Imperative in Corporate Finance Jurisprudence (forthcoming in the Utah Law Review), explores the (seemingly nonexistent) role of the judiciary in shaping corporate financial law. Analyzing finance and lending jurisprudence, including cases in the related areas of consumer finance and public finance, I discover a judicial narrative of restraint, deference and abstention.
In particular, the dominant judicial decision-making paradigm in lending and finance asserts that stable financial markets require an environment of “legal certainty,” which is achieved when courts exercise considerable restraint. In disputes that stem from private financial agreements, courts show restraint by narrowly tailoring opinions to strict construction and passive enforcement of underlying contracts, and by declining to extend common law doctrines.
I call this paradigm the “Certainty Imperative.” I trace the Imperative to decisions rendered in the wake of the economic instability of the late 1970s and early 1980s, and I find that the paradigm continues to dominate finance and lending jurisprudence to this day. In fact, it has been bolstered by state and federal statutes that further constrain judicial decision-making in the corporate financing realm.
Ostensibly a creature of neoclassical economic theory, the Imperative infuses the specific goal of stability in financial markets into the broader and more deeply entrenched normative theme of legal certainty. The Imperative is rooted in the belief that financial markets are vital to the national interest, and that judges ought to decide cases in this realm in a manner that advances broad economic efficiency goals. What is more, the Imperative reflects the neoclassical conviction that markets are inherently stable in the absence of governmental intervention (including via judicial decision).
Imperative-abiding courts invoke forceful language, expressing fear that a decision might “throw credit markets into confusion and destabilize this area of law,” Smith v. Anderson, 801 F.2d 661, 665 (4th Cir. 1986), or “disrupt orderly credit markets.” Algemene Bank Nederland v. Hallwood Indus., 133 B.R. 176, 180-81 (W.D. Pa. 1991). The Fourth Circuit went so far as to suggest a slippery slope, whereby a ruling adverse to the expectations of lenders might send tremors through the industry, causing “untold and unknown consequences that cannot now be fully foreseen,” “undefinable instability” and even “widespread confusion.” Cetto v. LaSalle Bank Nat’l Ass’n, 518 F.3d 263, 277 (4th Cir. 2008). Other times, courts express this Imperative in vague terms, as if to imply some universal understanding that markets are profoundly sensitive to judicial decisions that modify existing law. For instance, courts have referred to undefined “ripple effects,” Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 189 (1994), and the simply-stated policy concern: “credit markets may be affected.” In re Fracasso, 210 B.R. 221, 228 (Bankr. D. Mass. 1997).
Generally focused on the needs of financial institutions rather than borrowers, the Imperative promotes bright-line rules that provide “all prospective lenders the certainty that is so important to the effective operation of markets,” In re Bulson, 327 B.R. 830, 845 (Bankr. W.D. Mich. 2005), or that deliver “guiding principle[s] for those whose daily activities must be limited and instructed” by laws governing commercial transactions. Dirks v. S.E.C., 463 U.S. 646, 664 (1983). The theme is often invoked as a rationale for maintaining the legal status quo, as courts lament a seemingly inequitable outcome under current law, but decline to engage in legal reform out of concern that any deviation from the expectations of lenders might disrupt financial markets.
When we consider this judicial narrative in its historical context, the Imperative seems not to be a reasoned legal philosophy, but rather a consequence of a shaken economy and a loose synthesis of emerging academic theories that seemed to offer new direction for maintaining financial market stability.
In my opinion, if courts are to assume a meaningful role in financial law reform, the Imperative must be confronted and overcome. The dominant paradigm heavily privileges the legal status quo, and its methodological constraints are a paralyzing force on the judiciary. The Article provides an in-depth critique of the Imperative’s strict interpretive norms, and suggests several possibilities for expanding the scope of judicial inquiries in the corporate financing realm.
I welcome your comments, questions and reactions!
Alas, this is the last post of my guest blogging stint here at the Glom. Thanks again for an informative and transformative 2-week set of experiences and memories.
I second Erik's post about law schools fostering humility. Eric poses these 2 fundamental questions:
1. Can one be both ambitious and humble?
2. Can law schools both inspire to dream large dreams -- personal and social -- while still warning about our own fallibility and the limitations of law?
I believe and hope that the answer to both of Eric's questions is yes.
1) Ambition is a great motivator for action, but unless ambition is accompanied with humility ambition often leads to arrogance, conceit, and hubris. A consequence of ambition often is great power and as is often quoted, "with great power comes great responsibility."
2) Not only law schools, but also such other professional schools as those for business, medicine, and public policy can and should "both inspire to dream large dreams -- personal and social -- while still warning about our own fallibility and the limitations of" the profession for which they are preparing their students to enter.
I will be teaching Legal Ethics and Professionalism for the first time next semester and have decided after detailed consideration of the many books and supplements from Aspen, Foundation, and Lexis to adopt these 3 books:
a) Nancy Levit and Douglas O. Linder, The Happy Lawyer: Making A Good Life in the Law (2010), ISBN: 978-0195392326. This book is just a wonderful source for law students and lawyers about recent scholarship about happiness and how to balance professional work and personal life. More generally, the book helps readers think about and find meaning in their quest for a satisfying career in the law.
b) Scott L. Rogers, Mindfulness for Law Students: Using the Power of Mindfulness to Achieve Balance and Success in Law School (2009), ISBN: 978-0977345519. This little paperback is another great resource for law students to help them integrate mindfulness into their busy and stressful lives.
Leonard Riskin, the Chesterfield Smith Professor of Law at the University of Florida, who currently is visiting at Northwestern law school, has been a long-time pioneer in championing the benefits of practicing mindfulness to law and mediation:
3) Michael C. Ross, Ethics and Integrity in Law and Business: Avoiding "Club Fed" (2011), ISBN: 978-1422479704. This paperback textbook succeeds at being a delightfully engaging, fresh, funny, and practical take on the professional responsibility course, which is often required in law school. This book contains many relevant quotes from authors, economists, humorists, judges, philosophers, and scientists. It also has wonderfully on point cartoons and comics from the Wall Street Journal and P. C. Vey, among others.
This book imparts much pragmatic wisdom about how to choose ethical behavior during tough economic times.
Not surprisingly to readers of Glom who have read my posts about business movies, I also plan to show film and television show clips in class to provoke discussion about violations of ethical rules and what sort of lawyers and values are possible and which of those possibilities are likely to lead to personal happiness and professional satisfaction. For example, three recent television programs that raise issues related to professional ethics and personal values are these:
I close this post and my guest blogging by providing the opening two paragraphs from a just completed manuscript, Tiger Cub Strikes Back: Memoirs of an Ex-Child Prodigy About Parenting and Legal Education. This working paper is related to many of the issues and themes I've raised in the 10 posts during this 2-week guest blogging opportunity. And yes, the first paragraph may seem to be immodest and ironic after discussing the importance of humility. The reason to include that paragraph in this post is that everything in that paragraph is true and verifiably so. Also, this post advocates true humility and not false humility. It would be an exercise in false humility to hide or deprecate my own past for the mere sake of appearing humble.
I believe that Amy Chua, tiger mom and Yale law professor, would see my life as exemplifying successful tiger parenting. I am an American born Chinese, who at age 14 enrolled as a freshman at Princeton University and 3 years later at age 17 after being a University Scholar there graduated Phi Beta Kappa earning an A.B. in mathematics. I also earned a Ph.D. in applied mathematics from Harvard University and a J.D. from Stanford University (after having been a 1L at the University of Chicago). My Ph.D. thesis advisor was 1972 economics Nobel Laureate and mathematical economic theorist, Kenneth Joseph Arrow. After serving as an economist in the Division of Consumer Protection in the Bureau of Economics of the Federal Trade Commission, I taught in economics departments from coast to coast, including at Stanford University, the University of California Berkeley, and the University of California Los Angeles; in the finance department of the A.B. Freeman business school at Tulane University; and in law schools at Yale University, University of Chicago, University of Pennsylvania, University of Virginia, University of Minnesota, and University of Southern California. I co-authored a law school course book about law and popular culture, while a member of the Institute for Advanced Study School of Social Science, during its psychology and economics thematic focus academic year. I am currently a professor and the inaugural DeMuth Chair at the University of Colorado School of Law after having been a professor and the inaugural Kohn Chair at Temple University law school.
This Essay reflects upon the desirability, efficacy, and motivational consequences of having a tiger mom such as Professor Chua or my own immigrant mother, who is a New York University medical school biochemistry professor. This Essay also points out many similarities between mainstream modern American legal education and tiger parenting, including their common hierarchical, top-down learning environments that entail authority, compliance, extrinsic incentives, fear, memorization, obedience, paternalism, precedent, and respect for one’s elders. The educational methodologies and philosophies of tiger parenting and the prevailing orthodoxy of United States legal instruction, especially the substantive content of the standard first year law school curriculum, explicitly and implicitly privilege a type of information processing known as system two over a type of information processing known as system one. System two reasoning is analytical, cognitive, conscious, controlled, deliberative, effortful, logical, rule-based, and slow; while system one is affective, associative, automatic, fast, habitual, heuristic-based, holistic, intuitive, and unconscious. Ironically, the Socratic method of legal instruction often places a premium on answering a professor’s questions aggressively, quickly, or superficially instead of deeply, mindfully, or thoughtfully.
I highlight some additional benefits to lawyers from paying attention to and learning more about emotions by recommending these five items to read.
First, the weekly faculty colloquium here yesterday was an intriguing talk by University of Wyoming College of Law Professor Michael R. Smith, who presented his work-in-progress titled, The Sociological and Cognitive Dimensions of Policy-Based Persuasion. Here is his summary of it:
Arguments based on public policy are critical to legal advocates, especially when they are arguing to a court on an issue of first impression. Interestingly, however, very little serious literature has been produced about the nature of policy arguments and how legal advocates can use them to best effect. This presentation, based on a work-in-progress, will explore the nature of policy-based persuasion in terms of sociology theory and cognitive psychology theory. Based on principles borrowed from these disciplines, the presentation will identify different types of policy arguments and will explore strategies for maximizing the persuasive impact of policy arguments in legal advocacy.
One of his main points was the difference between emotional narratives versus emotional policy arguments. For more related work, see his thoughtful book Advanced Legal Writing: Theories and Strategies in Persuasive Writing:
Second, see this article by Jules Lobel and George Loewenstein titled, Emote Control: The Substitution of Symbol for Substance in Foreign Policy and International Law. As they describe their article in this abstract:
Historical perspectives, as well as recent work in psychology, converge on the conclusion that human behavior is the product of two or more qualitatively different neural processes that operate according to different principles and often clash with one another. We describe a specific 'dual process' perspective that distinguishes between deliberative and emote control of behavior. We use this framework to shed light on a wide range of legal issues involving foreign policy, terrorism, and international law that are difficult to make sense of in terms of the traditional rational choice perspective. We argue that in these areas, the powerful influence of emotions not only on the general public, but on politicians and judicial decision makers, leads to a substitution of symbol for substance that can be seen at two different levels: (1) in the types of situations and stimuli that drive people to action (namely vivid symbols rather than rational arguments), and (2) in the types of actions that people take - specifically symbolic actions that are superficially satisfying as opposed to more substantive actions that are less immediately satisfying but actually more likely to produce desired long-term results.
Third, see this article by Deborah A. Small and Jennifer Lerner titled, Emotional Policy: Personal Sadness and Anger Shape Judgments about a Welfare Case. Here is their abstract of their article:
When making decisions about a welfare case, it is reasonable for one’s thoughts and feelings about the potential welfare recipient to influence the decision. It is less reasonable for one’s “incidental” feelings (e.g., sadness or anger arising from an event in one’s personal life) to influence such decisions. In two studies, however, data reveal that incidental anger and sadness do in fact carry over, shaping welfare policy preferences. Study 1 found that incidental anger decreased the amount of welfare assistance participants recommended providing relative to neutral emotion, whereas sadness increased the amount recommended. Study 2 replicated the results and found that limiting participants’ cognitive resources eliminated the difference between sadness and anger, thus implying that differences in depth-of-thought drove the effects. In sum, the results reveal ways in which: (a) personal emotions carry over to shape preferences for public policies, (b) emotions of the same valence have opposing effects, and (c) differential depth-of-cognitive-processing contributes to such effects.
Fourth, check out an article by Todd D. Peterson and Elizabeth Waters Peterson titled Stemming the Tide of Law Student Depression: What Law Schools Need to Learn from the Science of Positive Psychology explains how to effectively inoculate law students from learned depression by helping them utilize their signature character strengths.
Fifth, there is no better definitive single book about why happiness matters to law students, lawyers, and law firms than one by Nancy Levit and Douglas O. Linder titled The Happy Lawyer: Making a Good Life in the Law.