Law and Economics.

The NBER's Program on Law and Economics met in Cambridge on March 2. Program Director Christine M. Jolls of Yale Law School organized the meeting. These papers were discussed:

Louis Kaplow, Harvard Law School and NBER, "Optimal Policy with Heterogeneous Preferences"

Discussant: Chris Sanchirico, University of Pennsylvania School of Law

Abraham Wickelgren, Northwestern University School of Law, "The Economics of Constitutional Rights and Voting Rules"

Discussant: Joshua Fischman, Tufts University 

Benjamin E. Hermalin, University of California, Berkeley, and Michael S. Weisbach, University of Illinois and

NBER, "Transparency and Corporate Governance"(NBER Working Paper No. 12875)

Discussant: Nicola Persico, New York University and NBER

Steven Shavell, Harvard Law School and NBER, "On Optimal Legal Change, Past Behavior, and Grand fathering"

Discussant: Christopher Snyder, Dartmouth College 

Edward Morrison, Columbia Law School, "Bargaining Around Bankruptcy: Small Business Distress and State Law"

Discussant: Albert Choi, University of Virginia School of Law 

Christopher Avery and Alvin E. Roth, Harvard University and NBER; Christine M. Jolls; and Richard A. Posner, United States Court of Appeals, "The New Market for Federal Judicial Law Clerks"

Discussant: Betsey Stevenson, Wharton School, University of Pennsylvania

Jesse Rothstein, Princeton University and NBER, and Albert H. Yoon, Northwestern University School of Law "Affirmative Action in Law School Admissions: What Do Racial Preferences Do?" and "Mismatch in Law School"

Discussant: Justin Wolfers, Wharton School, University of Pennsylvania

Suzanne Scotchmer, University of California, Berkeley and NBER, "Risk Taking and Gender in Hierarchies"

Discussant: Ian Ayres, Yale Law School and NBER

Optimal policy rules--including those regarding income taxation, commodity taxation, public goods, and externalities--are typically derived in models with preferences that are homogeneous. Kaplow reconsiders many central results for the case in which preferences for commodities, public goods, and externalities are heterogeneous. When preference differences are observable, standard second-best results in basic settings are unaffected, except those for the optimal income tax. Optimal marginal income tax rates may be higher or lower on types who derive more utility from various goods, depending on the nature of preference differences and the concavity of the social welfare function. When preference differences are unobservable, all policy rules may change. The determinants of even the direction of optimal rule adjustments are many and subtle.

Constitutions typically specify that some laws require greater levels of support to pass than others. Laws that overturn protected constitutional rights, for example, are much harder to pass than are most other laws. Wickelgren analyzes how the characteristics of a law influence how much support the law should have in order to pass. He shows that while the expected total benefit from a law should not affect the optimal vote share required for passage, the dispersion in gains and losses should. The fraction of winners from a law has a nonmonotonic effect on the optimal vote share. These results can help one understand what "rights" deserve constitutional protection and what "rights" do not.

An objective of many proposed corporate governance reforms is increased transparency. This goal has been relatively uncontroversial, as most observers believe that increased transparency is unambiguously good. Hermalin and Weisbach argue that, from a corporate governance perspective, there are likely to be both costs and benefits to increased transparency, leading to an optimum level beyond which increasing transparency lowers profits. This result holds even when there is no direct cost of increasing transparency and no issue of revealing information to regulators or product-market rivals. The researchers show that reforms that seek to increase transparency can reduce firm profits, raise executive compensation, and inefficiently increase the rate of CEO turnover. They further consider the possibility that executives will take actions to distort information. They show that executives could have incentives, because of career concerns, to increase transparency and that increases in penalties for distorting information can reduce profit.

When is it socially advantageous for legal rules to be changed in the light of altered circumstances? In answering this basic question, Shaven develops a simple point--that past compliance with legal rules tends to reduce the social advantages of legal change. The reasons are twofold: adjusting to a new legal rule often involves costs; and the social benefits of change are frequently only incremental, only in addition to those of past compliance. The general implications are that legal rules should be more stable than would be appropriate were the relevance of past behavior not recognized, and that a policy of grandfathering, namely, of permitting noncompliance, should sometimes be employed. The analysis of these points is general, applying across legal fields, often explaining what we observe but also indicating possibilities for reform, such as in the regulation of air pollution. The analysis is related to the conventional reliance-based justification for the stability of the law and to the literature on legal transitions.

Discussions of small-business bankruptcy typically focus on the United States Bankruptcy Code. But few failing small businesses--around 20 percent--use federal law to reorganize or liquidate. Most use state insolvency laws for these purposes. State laws include foreclosures, bulk sales, and assignments for the benefit of creditors. Relative to federal law, these procedures are often faster, more private, and less costly to the debtor and its senior creditors. The procedures vary substantially by state in the protection offered to creditors. Morrison documents the interplay between state and federal bankruptcy law and how this dynamic varies by state. Drawing on two datasets--state-level data from public records and firm-level data from Dun & Bradstreet records--he shows that failing small business corporations and their senior creditors bargain around federal law. Because a debtor needs senior creditor consent to invoke many state procedures, a bankruptcy filing occurs only when the senior creditor distrusts the debtor and withholds consent. Morrison shows that a small business corporation is more likely to use bankruptcy law if it is encumbered by secured debt or tax liens and if it has defaulted or otherwise impaired its relationship with senior creditors. State procedures are more common in states with regulations that promote the transparency of the insolvency process and give senior lenders leverage to attack insider self-dealing. These findings suggest that any reform of federal bankruptcy law will have two effects: it will affect outcomes in federal courts (intensive margin) and the debtor's choice between state and federal procedures (extensive margin). Variation along the extensive margin can neutralize reforms in federal law, as when a reform designed to protect unsecured creditors induces businesses to use less protective state procedures instead. The findings in this paper also raise questions about the appropriate balance between state and federal law. The primary function of the Code is to serve as a backstop when bargaining fails, but state law could better serve the same function. The optimal balance between state and federal law, then, may be one that gives states greater authority to regulate small business bankruptcy.

In the past, judges have often hired applicants for judicial clerkships as early as the beginning of the second year of law school, for positions commencing approximately two years down the road. In the new hiring regime for federal judicial law clerks, by contrast, judges are exhorted to follow a set of start dates for considering and hiring applicants during the fall of the third year of law school. Using the same general methodology as they employed in a study of the market for federal judicial law clerks conducted in 1998-2000, Avery, Jolls, Posner, and Roth have broadly surveyed both federal appellate judges and law students about their experiences of the new market for law clerks. This article analyzes their findings within the prevailing economic framework for studying markets with tendencies toward "early" hiring--a framework they both draw upon and modify in the course of their analysis. The data make clear that the movement of the clerkship market back to the third year of law school is highly valued by judges, but the authors also find that a strong majority of the judges responding to their surveys concluded that non-adherence to the specified start dates is very substantial--a conclusion the authors are able to corroborate with specific quantitative data from both judge and student surveys. The consistent experience of a wide range of other markets suggests that such nonadherence in the law clerk market will lead to either a reversion to very early hiring or the use of a centralized matching system such as that used for medical residencies. The authors suggest, however, potential avenues by which the clerkship market could stabilize at something like its present pattern of mixed adherence and non-adherence, thereby avoiding the complete abandonment of the current system.

Rothstein and Yoon examine the so-called "mismatch" hypothesis in the context of law school admissions. They discuss what sort of evidence might support or work against claims of mismatch effects. Using two data sources and their preferred approach, they find that claims of the mismatch hypothesis are significantly overstated, particularly with respect to employment outcomes. Nevertheless, the data are consistent with some mismatch, concentrated among the students with the lowest entering credentials. To put these estimates in context, they simulate the elimination of affirmative action. This would lead to drastic reductions in the number of black law school matriculants, particularly at the most selective schools, without managing to eliminate mismatch between black and white students. This magnitude of the displacement dominates that of mismatch, so elimination of preferences would dramatically reduce the number of practicing black lawyers.

In their second paper, the same authors use two comparisons to identify so-called "mismatch" effects in law schools, with consistent results. There is no evidence of mismatch effects on graduation or bar passage rates of black students above the bottom quintile of the entering credentials distribution. The data are consistent with mismatch effects for bottom-quintile black students but do not demonstrate the importance of these effects, as sample selection bias is a potentially important confounding factor in this range. There is no evidence from any comparison of mismatch effects on employment outcomes.

If promotion in a hierarchy is based on a random signal of ability, then rates of promotion are affected by risk taking. Further, the statistical properties of the surviving populations of risk takers and non-risk takers will be different, and will be changing throughout the hierarchy. Scotchmer defines promotion hierarchies with and without memory, where memory means that promotion depends on the entire history of success. In both types of hierarchies, surviving risk takers have lower average ability than surviving non-risk takers at any stage where they have a higher probability of survival. However, that will not apply in the limit. With a common set of promotion standards, risk takers will survive with lower probability than non-risk takers, and will have higher average ability. Scotchmer gives several interpretations for how these theorems relate to affirmative action, in light of considerable evidence that males are more risk taking than females.