Econ 200 Foldvary, Law and Economics


President Barack Obama has signed the National Defense Authorization Act of 2013.

This bill authorizes indefinite detention for US citizens.

The NDAA allows the military to detain United States citizens indefinitely without charge or trial for mere suspicions of ties to terrorism.

Under the 2012 NDAA, Pres. Obama agreed to give the military the power to arrest and hold Americans without the writ of habeas corpus, although he promised that his administration would not abuse that privilege.

Amendment V

No person shall be deprived of life, liberty, or property, without due process of law;


The Code of Federal Regulations, where rules are stored, is more than 169,000 pages long.

Small businesses spend more than $10,000 per employee per year to comply with federal rules

Deregulation of trucking, airlines, interest rates,

enhanced the market.

Did deregulation of financial firms and transactions contribute to the Great Recession?

Congress increased deposit insurance to $100,000.

In most cities, the local governments grant a single cable television company a monopoly franchise. The government shares in the 'loot' by taxing a portion of the monopoly profits.

California allegedly deregulated electricity.

But government in California set the consumer prices, prevented electricity firms from entering into long-term contracts, and hampered the building of power plants.

Over the past decade, federal regulations with cost estimates have made up

less than half a percent of the total annual rule flow of over 3,500.

Of the few hundred major rules among these that get reviewed by the Office of Management and Budget (OMB), fewer than 35 percent have quantitative cost estimates.

Rules featuring benefit calculations are even rarer;

Fewer than three-tenths of a percent of all rules finalized show benefit estimates.

Of the few hundred of these rules reviewed at OMB, fewer than a quarter get quantified annually.

Cost and benefit review of entire categories of regulated economic enterprise get left out, too.

Independent agencies like the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Federal Reserve get no review.

Articles in Forbes Dec 31 2012 “The Costberg.”

Wayne Crews:

The year 2012 just concluded with a 76,875 page Federal Register containing 3,706 rules.

Ahead are new ones on finance, healthcare, energy and the environment.

Annual Economic Regulation Costs: $373 Billion

Annual Executive Agency Social Regulation Costs: $441 Billion

Independent Agencies’ Annual Regulatory Costs $4.5 billion

Certain Paperwork and Information Collection Costs $26 billion

Tax Compliance Costs: $300 Billion

These add up to $1.14 trillion annually.

Additional executive and independent agency regulatory costs

such as for health services ($184 billion),

telecommunications ($141 billion)

and homeland security ($55 billion)

–bring the total placeholder estimate to $1.8 trillion.

These costs are entirely off-budget.

Louis Kaplow & Steven Shavell, Fairness Versus Welfare

Cooter & Ulen notes

Under welfare economics, policies are assessed exclusively in terms of their effects on the

well-being of individuals.

Whatever is relevant to individuals’ well-being is relevant under welfare economics.

This view is in contrast to the normative economic analysis under which legal rules are assessed by reference to wealth maximization or efficiency,

and which omits important aspects of individuals’ well-being, as well as distributive concerns.

When decisions are based on the notion of fairness, they depend on instincts and intuitions. These have no proper place in the design of the research agenda of legal academics

and other policy analysts who are engaged in analyzing the legal system

in order to identify which legal rules are socially best.

Louis Kaplow & Steven Shavell, “Why the Legal System Is Less Efficient Than the Income Tax in Redistributing Income,” 23 J. Legal Stud. 667 (1994).

That common law or private adjudication should strive for efficiency,

while matters of distributive equity should be handled by the tax-and-transfer system.

Kaplow and Shavell make a “tax-substitution” argument.

For every redistributional legal rule,

we can find an alternative tax surcharge that accomplishes precisely the same redistribution

but also raises tax revenue.

This tax revenue can then be distributed to the population or used for public goods.

Any redistribution accomplished by adjusting legal rules away from efficient standards

can be more efficiently accomplished by leaving the efficient legal rule as it is

and accomplishing the equitable goal with taxes.

Chris Sanchirico, “Deconstructing the New Efficiency Rationale,” 86 Cornell L. Rev. 1005 (2001). of the Wharton School and the Law School at the University of Pennsylvania

has produced some criticisms of the Kaplow-Shavell argument.

Traditionally in law and economics the principal mode of analysis has been to evaluate legal rules according to the sole criterion of “efficiency.”

This has meant that we should evaluate rules by the sum of the costs and benefits that they impose on individuals without regard to how those costs and benefits are distributed among different individuals.

Conditioning the application of legal rules on parties’ incomes will affect their decisions in the labor market in much the same way as directly taxing their earnings.

Sanchirico opposes the efficiency-only rationale and holds that the legal rule has a redistributional impact whenever it affects different individuals differently and that this redistributional impact should figure centrally in our evaluation of legal rules.

Also, redistribution thru the law may be more efficient than extra redistribution via taxation.


A trust: A fiduciary relationship in which one party,

known as a trustor or settlor (testator if after death),

gives another party, the trustee,

the right to hold title to property or assets

for the benefit of a third party, the beneficiary.

Living Trust (inter-vivos): A trust that is in effect during the trustor's lifetime.

In common law legal systems, a trust is a relationship whereby property

(real or personal, tangible or intangible) is held by one party for the benefit of another.

Revocable and Irrevocable.

After you place property into an irrevocable trust, you can't retrieve the property.

That property now belongs to the trust.

With a revocable trust, you can place property into the trust

and at some point in the future, undo the transfer

by removing the property and terminating the trust.

Living trusts are a way to totally avoid probate.

You need to make sure that major assets are held in the trust form.

Forms of enterprise: sole, partner, association, trust, corporation.

Corporate meaning of “trust”

An organization of corporations that together create market power.

Companies producing several products enter into a cartel.

Large shareholders transferred controlling shares of stock to the board of the cartel,

to be held in trust for the shareholders.

The shareholders received trust certificates, entitling them to receive dividends,

although voting control was delegated to the board of the trust.

The trustees elected the boards of the corporations.

Such trusts have been replaced by holding corporations.

But anti-monopoly policy is still called “anti-trust.”

Stephen Spurr: Economic Foundations of Law

Chapter 11, Corporation Law

The law and economics of corporations

(corporations not in Friedman index.)

Corporation: free market, or privilege?

Most output from corporations. Why?

Easier to obtain investments via shares of stock.

Partnerships can also have limited liability and transferable shares, continuity.

Principal-agent problem

(not in index of Law’s Order.)

The separation of ownership from control.

Ownership: a bundle of rights.

The shareholders delegate some rights to the board of directors,

which delegates rights of control to the CEO.

Many shareholders indirectly own shares via mutual funds.

Shareholders usually seek to maximize long-term profit.

Agents seek to maximize their own utility.

Shareholders have limited information.

Financial incentive for agents: shares of stock, options.

The incentive should be for long-run profit,

but it is often for short-run current profit, which is easier to measure.

This creates the perverse incentive to inflate current profit.

Boards are often not truly independent.

Laws limit the deductibility of executive pay to $1 million.

Covered employees are defined as the CEO as of the close of the taxable year and the three highest paid executive officers as reported in the proxy

(the CFO is excluded from the definition of covered employee).

Result: payment by stock options and shares of stock.

That dilutes the value of the shares.

Are CEOs over-compensated?

There could be long-term options and promised future shares.

The best incentive is non-monetary: sympathy with the firm.

The market for takeovers limits corporate overpayment and waste.

But laws limit takeovers: The Williams Act of 1968 and others.

The Williams Act requires disclosure for a person that obtains 5% or more of the stock.

Management may sue for an injunction to delay a tender offer.

This increases the costs of takeovers.

The price of shares rises with advance notice.

These laws have reduced takeovers.

The incentives to maximize long-term profits have been diminished.

Also corporate rules that require a merger to be approved by a super-majority such as 80%.

Corporations file lawsuits alleging anti-trust violations.

Greenmail: offering to buy back stock from a hostile bidder on favorable terms.

The poison pill: in the corporate charter; “shareholder rights plans”.

When someone obtains a particular proportion of shares (e.g. 15%),

other shareholders have the right to acquire shares at a discount.

The plan can be issued by the board as an "option" or a "warrant" attached to existing shares.

Warrants are similar to stock options.

Warrants issued by the company are dilutive.

When the warrant issued by the company is exercised,

the company issues new shares of stock, so the number of outstanding shares increases.

When a call option is exercised,

the owner of the call option receives an existing share from an assigned call writer

(except in the case of employee stock options, where new shares are created and issued by the company upon exercise)

“Shareholder rights plans” are unlawful without shareholder approval in the United Kingdom. The are lawful in Delaware.

Another aspect of corporate law is the competition by the U.S. States for incorporation.

Incorportating is a legal privilege.

The state receives a franchise tax.

Incorporation also increases the demand for legal services within the state.

State law might benefit incumbent management at the expense of shareholders.

These laws might enable opportunism by management.

An alternative could be federal charters.

In efficient markets, a corporation that loots its shareholders would lower the price of shares.

Insider trading

Using non-public information for trades of securities.

Applies to corporate insiders and tipees.

Should it be permitted?

Argument for: the price of a share would include more information.

Disclosure could damage the profits of the firm.

Insider trading provides an incentive to increase value.

Argument against: selling (including shorts) harms shareholders relative to insiders.

Insider trading rewards information rather than entrepreneurship.

A remedy: meta disclosure: in charger, whether the firm allows it.

Conflicts among shareholders

Under Delaware law, a majority of shareholders can force a minority to sell shares to the corporation. Shareholders are entitled to a judicial appraisal of the value.

Thus the majority has the power of corporate eminent domain.

Corporations with more than a prescribed number of shareholders are considered publicly held.

The Federal Securities Exchange Act of 1934 states that corps of more than $5 million of assets and securities held by more than 500 shareholders are subject to special regulation,

including public disclosures.

The corporate eminent domain can reduce the shares without a holdout problem.

Double taxation

Corporations are subject to the double taxation of corporate profit.

There are two income taxes, one on natural persons and one on corporations as legal persons. Corporations are owned by their shareholders,

so in reality the shareholders end up paying some of the tax on corporate profits.

Some of the tax is passed onto consumers, and the rest falls on workers, reducing their employment and wages.

Then when a corporation pays dividends to its shareholders,

the dividends are personal income, and taxed again by the personal income tax.

Some countries, such as the U.K., only tax corporate profits once,

but U.S. and state shareholders pay a double tax on dividends.

The tax rate on dividend income is a bit lower than for wage income,

but that does not eliminate the double tax.

The double taxation of dividends induces some corporations to avoid paying dividends,

and it encourages excessive borrowing as a substitute for issuing more stock.

The large debt burden of corporations is to a large extent the result of the income tax.

This debt makes corporations fail when profits fall,

because they can't afford to pay the interest.

If instead of debt they issued more stock,

the fall in profits would just reduce the dividends.

The abolition of the corporate income tax would eliminate this double taxation.

However, so long as the personal income tax exists,

corporate profits should be taxed the same as the profits or income of natural persons.

If the profits are not paid out in dividends,

then the shareholders should pay that tax on retained earnings and unrealized gains.

In partnerships, the partners pay the tax on profits once;

corporations should be treated the same.

Reform of corporate law

Corporations can become more democratic by decentralizing the voting by shareholders.

The way it works now is that the shareholders vote for members of the board of directors.

The corporation sends the shareholders some information about the board candidates, as well as any issues to be voted on.

The shareholder's votes equal the number of shares held, and the vote can be submitted by mail, on the Internet, or in person at the annual meeting.

Most shareholders know little or nothing about the board candidates.

They get a report on the operations of the company,

but very few shareholders read or understand the detailed accounting and footnotes.

The board candidates are typically picked by the current board members,

and often the chief executive officer will be influential in selecting candidates.

The result is too often a self-perpetuating clique

that indulges in excessively high rewards for the corporate chiefs and board members

at the expense of the shareholders.

Corporate governance, like political government, is only formally democratic.

In substance, the governance of a typical corporation is an oligarchy,

ruled by a few powerful men.

The main power of a shareholder is the ability to sell the shares

rather than vote for the board which is supposed to represent him.

Corporate democracy can be strengthened by making it more indirect and decentralized.

Instead of directly electing the board members,

the shareholders would vote for delegates, who would then elect the board.

It would be like the U.S. voting method for president.

Voters do not directly elect the president, but rather vote for members of an electoral college, who then elect the president.

The U.S. system has changed into a direct election of the president in substance,

since the electoral college has become a rubber stamp.

The corporate delegates would instead operate the way

the U.S. electoral college was originally intended.

The corporate electoral delegates would represent particular types of shareholders. If there are shareholders who hold more than five percent of the shares, they would be their own delegates. Mutual Funds that own shares in the firm would elect delegates that would represent them. Other institutions such as insurance companies would have institutional delegates. Individual shareholders would vote for delegates who represent the small shareholders.

Any shareholder could nominate himself as a candidate to be a delegate.

The delegates would have or obtain expertise in the firm's board candidates

and the operations of the company.

Delegates would have fiduciary liability for being ethical,

such as not having conflicts of interest.

The delegates would meet personally and discuss the candidates,

and then elect the board by majority vote.

The delegates would continue to represent the shareholders until the next election. With a two-thirds majority, the delegates would be able to unseat a board member. The delegates could also issue reports to the shareholders on how well the firm is doing, supplementing and interpreting corporate reports as well as news about the firm.

This indirect democracy would be more democratic than today's direct elections.

The delegates would provide leverage for the voter.

As it is today, the shareholder's votes are almost meaningless.

The descriptions of the board members do not really inform the shareholder about the dedication and competence of the board member.

Few shareholders have the knowledge to understand complicated issues such as stock options. Electing independent expert electoral delegates would bring real shareholder control to corporations.

Then concerns over corporate policy, such as their treatment of workers and the environment, would be much more sensitive to shareholders's wishes.

The indirect election of board members would require new federal and state legislation.

Gun control law and economics

Concealed weapons save lives, by John R. Lott, Jr., July 2012

Multiple-victim public shootings in the U.S. (in which more than three people have been killed) since at least 1950 have taken place where citizens are not allowed to carry their own firearms.

There have been mass murders in Europe, with strict gun controls.

The Cinemark movie theater in Aurora, Colorado, like others run by the chain around the country, displayed warning signs that it was illegal to carry guns into the theater.

There have been many shootings that were stopped by armed civilians.

The civilian version of the AK-47 is not the machine gun used by militaries around the world. The civilian version merely looks like the military version on the outside, but its inside guns are the same as a deer-hunting rifle.

The civilian version uses essentially the same sorts of bullets as deer-hunting rifles,

fires at the same rapidity (one bullet per pull of the trigger) and does the same damage.

Lott says that there is a “very good chance” the Connecticut school shooting could have been averted, if teachers there were permitted to carry concealed handguns.

Mass shootings repeatedly have occurred in designated gun-free zones

Fashion and copyright

Edward Lopez

Should fashion designs be eligible for copyrights?

Copying releases new fashions from the small circles of their origins to the wider marketplace;

it translates designs from abstract experimentation on the catwalk

to concrete wearability on the sidewalk.

Trademark protects certain features in fashion design like brand names, logos, and unique attributes that consumers use to identify designs with a particular brand.

The stitched polo player on Ralph Lauren’s shirts is protected,

but the overall design of the shirt is not.

As for patents, the process is too slow and its standards of novelty too strict for fashion.

[A] man’s property is limited by the chattels of his invention,”

wrote Judge Learned Hand in an important 1929 case involving dress designs,

Cheney Bros. v. Doris Silk. “Others,” he concluded, “may imitate these at their pleasure.”

The lack of copyright does not appear to have been significantly costly to the industry..


Written assignment: propose three significant changes in corporate law that would benefit shareholders, and possibly also the economy. Justify your proposals.