Overconfident CEOs over-estimate their ability to generate returns. Thus, on the margin, they undertake mergers that destroy value. They also perceive outside finance to be over-priced. We classify CEOs as overconfident when, despite their under-diversification, they hold options on company stock until expiration. We find that these CEOs are more acquisitive on average, particularly via diversifying deals. The effects are largest in firms with abundant cash and untapped debt capacity. Using press coverage as "confident" or "optimistic" to measure overconfidence confirms these results. We also find that the market reacts significantly more negatively to takeover bids by overconfident managers.
{"title":"Who Makes Acquisitions? CEO Overconfidence and the Market's Reaction","authors":"Ulrike Malmendier, Geoffrey Tate","doi":"10.2139/ssrn.470788","DOIUrl":"https://doi.org/10.2139/ssrn.470788","url":null,"abstract":"Overconfident CEOs over-estimate their ability to generate returns. Thus, on the margin, they undertake mergers that destroy value. They also perceive outside finance to be over-priced. We classify CEOs as overconfident when, despite their under-diversification, they hold options on company stock until expiration. We find that these CEOs are more acquisitive on average, particularly via diversifying deals. The effects are largest in firms with abundant cash and untapped debt capacity. Using press coverage as \"confident\" or \"optimistic\" to measure overconfidence confirms these results. We also find that the market reacts significantly more negatively to takeover bids by overconfident managers.","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"65 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2003-03-15","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"76883132","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Oil & gas projects consist of a series of options. The mineral owner must first decide whether to spend money on "exploration" in order to learn the extent of potential reserves, the cost and timing of recovering the reserves, and the probability that the reserves are actually recoverable. The mineral owner holds an "exploration option" since the owner need not explore immediately but may wait until an increase in mineral prices makes the potential rewards from exploration more promising. After exploration of a property, the owner holds a "development option." The owner may pay to drill a test well to see if the reserves are recoverable, or the owner may put off any such test until prices are higher. If the test well proves there are recoverable reserves, the owner has a "production option." This option consists of the ability to complete the test well as a producer, and to drill and complete any other wells required to completely drain the recoverable reserves. The incentives for exploration, development, and production depend on the "threshold prices" at which an investor will execute each option. This article examines the impact of various tax policies on exploration and development threshold prices, using a simplified production model that collapses the production option into the development option. Capitalizing rather than expensing development costs (such as intangible drilling costs) creates incentives to do projects that have a lower probability of success, that have shorter well lives, and that have lower development costs. This shift in incentives creates a nonneutrality, causing investors to develop some properties prematurely while unduly delaying the development of other projects. Capitalizing development costs also causes a slight increase in the exploration threshold price and therefore reduces exploration. Capitalizing rather than expensing exploration costs (such as the costs of seismic analysis to detect potential underground deposits) results in a more complicated pattern of effects. This policy causes a large increase in the exploration threshold price, thereby reducing exploration. Since the taxpayer will not recover capitalized exploration costs until development, this policy also reduces the cost of development and lowers development threshold prices. As a consequence, capitalizing exploration costs results in more intensive development and production of known reserves as well as reduced exploration. This pattern is undesirable if the goal is to enhance national security by encouraging the creation of a pool of reserves that are available for immediate exploitation in case foreign supplies become unavailable. It also is possible that taxpayers may be able to circumvent most of the impact of rules requiring capitalization of exploration costs by strategically realizing losses. This possibility may blunt the undesirable national security impact of such rules, but the costs of the associated trading are social costs that would
{"title":"Taxes and Non-Renewable Resources: The Impact on Exploration and Development","authors":"Jeff Strnad","doi":"10.2139/ssrn.311278","DOIUrl":"https://doi.org/10.2139/ssrn.311278","url":null,"abstract":"Oil & gas projects consist of a series of options. The mineral owner must first decide whether to spend money on \"exploration\" in order to learn the extent of potential reserves, the cost and timing of recovering the reserves, and the probability that the reserves are actually recoverable. The mineral owner holds an \"exploration option\" since the owner need not explore immediately but may wait until an increase in mineral prices makes the potential rewards from exploration more promising. After exploration of a property, the owner holds a \"development option.\" The owner may pay to drill a test well to see if the reserves are recoverable, or the owner may put off any such test until prices are higher. If the test well proves there are recoverable reserves, the owner has a \"production option.\" This option consists of the ability to complete the test well as a producer, and to drill and complete any other wells required to completely drain the recoverable reserves. The incentives for exploration, development, and production depend on the \"threshold prices\" at which an investor will execute each option. This article examines the impact of various tax policies on exploration and development threshold prices, using a simplified production model that collapses the production option into the development option. Capitalizing rather than expensing development costs (such as intangible drilling costs) creates incentives to do projects that have a lower probability of success, that have shorter well lives, and that have lower development costs. This shift in incentives creates a nonneutrality, causing investors to develop some properties prematurely while unduly delaying the development of other projects. Capitalizing development costs also causes a slight increase in the exploration threshold price and therefore reduces exploration. Capitalizing rather than expensing exploration costs (such as the costs of seismic analysis to detect potential underground deposits) results in a more complicated pattern of effects. This policy causes a large increase in the exploration threshold price, thereby reducing exploration. Since the taxpayer will not recover capitalized exploration costs until development, this policy also reduces the cost of development and lowers development threshold prices. As a consequence, capitalizing exploration costs results in more intensive development and production of known reserves as well as reduced exploration. This pattern is undesirable if the goal is to enhance national security by encouraging the creation of a pool of reserves that are available for immediate exploitation in case foreign supplies become unavailable. It also is possible that taxpayers may be able to circumvent most of the impact of rules requiring capitalization of exploration costs by strategically realizing losses. This possibility may blunt the undesirable national security impact of such rules, but the costs of the associated trading are social costs that would","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"12 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2002-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"85871690","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
There has been significant recent interest among tax policy experts about various possible reforms for the tax treatment of convertible debt. Potential reforms center on removing the deductibility by issuers of interest or original issue discount for these instruments either unconditionally or conditional upon conversion. This paper begins with a review of the role that callable convertible bonds play in corporate finance in order to gauge the impact of particular reforms. The most salient explanations for the issuance of substantial quantities of these bonds and for issuer call policy after issuance hinge on the ability of issuers to signal their prospects through issuance and call policy. After considering the impact of adding taxes to an appropriate signalling model, the paper concludes that the envisioned reforms of the tax treatment of convertible debt may have a very large impact on the utility of convertible debt as a signalling device. However, the direction of the impact is uncertain. In view of the apparent importance of convertible debt as a financing vehicle, these results suggest abstaining from potential reforms until a clearer picture emerges.
{"title":"Taxing Convertible Debt","authors":"Jeff Strnad","doi":"10.2139/ssrn.311280","DOIUrl":"https://doi.org/10.2139/ssrn.311280","url":null,"abstract":"There has been significant recent interest among tax policy experts about various possible reforms for the tax treatment of convertible debt. Potential reforms center on removing the deductibility by issuers of interest or original issue discount for these instruments either unconditionally or conditional upon conversion. This paper begins with a review of the role that callable convertible bonds play in corporate finance in order to gauge the impact of particular reforms. The most salient explanations for the issuance of substantial quantities of these bonds and for issuer call policy after issuance hinge on the ability of issuers to signal their prospects through issuance and call policy. After considering the impact of adding taxes to an appropriate signalling model, the paper concludes that the envisioned reforms of the tax treatment of convertible debt may have a very large impact on the utility of convertible debt as a signalling device. However, the direction of the impact is uncertain. In view of the apparent importance of convertible debt as a financing vehicle, these results suggest abstaining from potential reforms until a clearer picture emerges.","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"34 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2002-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"89826494","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
An important challenge for all economies, at which only a few have succeeded, is creating the preconditions for a strong market for common stocks and other securities. A strong securities market rests on a complex network of legal and market institutions that ensure that minority shareholders (i) receive good information about the value of a company's business, and (ii) have confidence that a company's managers and controlling shareholders won't cheat them out of most or all of the value of their investment. This short paper summarizes this theory (which I develop in a separate paper on The Legal and Institutional Preconditions for Strong Securities Markets), and discusses the strengths and weaknesses of Brazil's institutions along these two dimensions. My goal is to offer a tentative roadmap for future reform of Brazilian institutions.
{"title":"Strengthening Brazil's Securities Markets","authors":"Bernard Black","doi":"10.2139/ssrn.247673","DOIUrl":"https://doi.org/10.2139/ssrn.247673","url":null,"abstract":"An important challenge for all economies, at which only a few have succeeded, is creating the preconditions for a strong market for common stocks and other securities. A strong securities market rests on a complex network of legal and market institutions that ensure that minority shareholders (i) receive good information about the value of a company's business, and (ii) have confidence that a company's managers and controlling shareholders won't cheat them out of most or all of the value of their investment. This short paper summarizes this theory (which I develop in a separate paper on The Legal and Institutional Preconditions for Strong Securities Markets), and discusses the strengths and weaknesses of Brazil's institutions along these two dimensions. My goal is to offer a tentative roadmap for future reform of Brazilian institutions.","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"34 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2000-10-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"82290414","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Empirical studies of post-ADA employment effects foreground a phenomenon that is puzzling. Although analyses suggest that employing workers with disabilities can be cost effective, and despite a burgeoning economy in which the unemployment rate for most categories of workers has plummeted, unemployment of working age individuals with disabilities appears not to have similarly diminished. From the point of view defined by scholars applying the neoclassical labor market paradigm to Title I, the clearest explanation of this phenomenon would seem to be that the studies reporting the cost effectiveness of employing the disabled are incorrect (even if only overstated). Following from this explication is the conclusion that selecting workers with disabilities over nondisabled workers is an inefficient practice. In what follows, I examine and assess the arguments made by proponents of the view that the inefficiency of employing workers with disabilities is a deterrent to their inclusion in the labor market. If these arguments are sound, then rational market forces appear to be inexorably at work to attenuate the strategy embodied by Title I of the ADA. To the contrary, however, I will identify a market failure that prevents certain employers from reaching rational labor market decisions by creating a "taste for discrimination" in which the costs of including people with disabilities in a workforce are perceived as being greater than they really are. Further, I will propose an improved manner for assessing the efficiency of employing workers with disabilities and consider what this method implies regarding the rationality of Title I's strategy. Finally, I will show that the failure of the existing neoclassical economic model, as well as the Title I critiques that rely on it, is attributable at least in part to societal misconceptions about people with disabilities being built into the model's assumptions. That is, far from being neutral or objective, these critiques sanction and perpetuate the very irrational biases the ADA was designed to correct.
{"title":"Labor Markets, Rationality, and Workers with Disabilities","authors":"M. Stein","doi":"10.2139/ssrn.230799","DOIUrl":"https://doi.org/10.2139/ssrn.230799","url":null,"abstract":"Empirical studies of post-ADA employment effects foreground a phenomenon that is puzzling. Although analyses suggest that employing workers with disabilities can be cost effective, and despite a burgeoning economy in which the unemployment rate for most categories of workers has plummeted, unemployment of working age individuals with disabilities appears not to have similarly diminished. From the point of view defined by scholars applying the neoclassical labor market paradigm to Title I, the clearest explanation of this phenomenon would seem to be that the studies reporting the cost effectiveness of employing the disabled are incorrect (even if only overstated). Following from this explication is the conclusion that selecting workers with disabilities over nondisabled workers is an inefficient practice. In what follows, I examine and assess the arguments made by proponents of the view that the inefficiency of employing workers with disabilities is a deterrent to their inclusion in the labor market. If these arguments are sound, then rational market forces appear to be inexorably at work to attenuate the strategy embodied by Title I of the ADA. To the contrary, however, I will identify a market failure that prevents certain employers from reaching rational labor market decisions by creating a \"taste for discrimination\" in which the costs of including people with disabilities in a workforce are perceived as being greater than they really are. Further, I will propose an improved manner for assessing the efficiency of employing workers with disabilities and consider what this method implies regarding the rationality of Title I's strategy. Finally, I will show that the failure of the existing neoclassical economic model, as well as the Title I critiques that rely on it, is attributable at least in part to societal misconceptions about people with disabilities being built into the model's assumptions. That is, far from being neutral or objective, these critiques sanction and perpetuate the very irrational biases the ADA was designed to correct.","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"1 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"2000-04-08","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"89133465","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this paper, we take an organizational view of organized crime. In particular, we study the organizational consequences of product illegality attending at the following characteristics: (i) contracts are not enforceable in court, (ii) all participants are subject to the risk of being punished, (iii) employees present a major threat to the entrepreneur having the most detailed knowledge concerning participation, (iv) separation between ownership and management is difficult because record-keeping and auditing augments criminal evidence.
{"title":"Optimal Law Enforcement and Criminal Organization","authors":"Nuno Garoupa","doi":"10.2139/ssrn.159219","DOIUrl":"https://doi.org/10.2139/ssrn.159219","url":null,"abstract":"In this paper, we take an organizational view of organized crime. In particular, we study the organizational consequences of product illegality attending at the following characteristics: (i) contracts are not enforceable in court, (ii) all participants are subject to the risk of being punished, (iii) employees present a major threat to the entrepreneur having the most detailed knowledge concerning participation, (iv) separation between ownership and management is difficult because record-keeping and auditing augments criminal evidence.","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"33 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"1999-03-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"81892284","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Abstract We analyze corruption in law enforcement: the payment of bribes to enforcement agents, threats to frame innocent individuals in order to extort money from them, and the actual framing of innocent individuals. Bribery, extortion, and framing reduce deterrence and are thus worth discouraging. Optimal penalties for bribery and framing are maximal, but, surprisingly, extortion should not be sanctioned. The state may also combat corruption by paying rewards to enforcement agents for reporting violations. Such rewards can partially or completely mitigate the problem of bribery, but they encourage framing. The optimal reward may be relatively low to discourage extortion and framing, or relatively high to discourage bribery.
{"title":"Corruption and Optimal Law Enforcement","authors":"A. Polinsky, S. Shavell","doi":"10.2139/ssrn.196529","DOIUrl":"https://doi.org/10.2139/ssrn.196529","url":null,"abstract":"Abstract We analyze corruption in law enforcement: the payment of bribes to enforcement agents, threats to frame innocent individuals in order to extort money from them, and the actual framing of innocent individuals. Bribery, extortion, and framing reduce deterrence and are thus worth discouraging. Optimal penalties for bribery and framing are maximal, but, surprisingly, extortion should not be sanctioned. The state may also combat corruption by paying rewards to enforcement agents for reporting violations. Such rewards can partially or completely mitigate the problem of bribery, but they encourage framing. The optimal reward may be relatively low to discourage extortion and framing, or relatively high to discourage bribery.","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"32 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"1999-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"90458927","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
A quarter of a century ago, Professor William Baxter published a widely read and influential book on the law and economics of pollution control entitled People or Penguins: The Case for Optimal Pollution. This paper pays tribute to Professor Baxter by using the logic of People or Penguins to examine current efforts to preserve biodiversity in the United States. The paper criticizes the failure of the Endangered Species Act to fully consider the costs of its regulatory mandates, but recognizes the complications of determining and balancing the benefits and costs of biodiversity preservation. The paper examines the Safe Minimum Standard Approach, urged by some economists as an alternative to traditional cost-benefit analysis in contexts such as species preservation, but ultimately rejects it as neither justifiable nor helpful. The paper suggests that domestic biodiversity policy should start by eliminating public subsidies that encourage the economically inefficient destruction of ecosystem components, by finding ways of commodifying ecosystem services, and by establishing a system of taxes and subsidies that send correct economic signals to property owners. Because many of these goals will be politically difficult to achieve at least in the short run, the "tailored commands" of the Endangered Species Act will continue to play an important role in protecting valuable species and ecosystems. But incorporation of rough cost-benefit considerations (taking account of uncertainties, irreversibilities, and intergenerational tradeoffs) into the Endangered Species Act would help the nation achieve a more optimal use of its scarce societal resources. An earlier version of this article was announced as Stanford Law School, John M. Olin Program in Law and Economics Working Paper No. 173. The working paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=149728
{"title":"People or Prairie Chickens: The Uncertain Search for Optimal Biodiversity","authors":"B. Thompson","doi":"10.2139/SSRN.205189","DOIUrl":"https://doi.org/10.2139/SSRN.205189","url":null,"abstract":"A quarter of a century ago, Professor William Baxter published a widely read and influential book on the law and economics of pollution control entitled People or Penguins: The Case for Optimal Pollution. This paper pays tribute to Professor Baxter by using the logic of People or Penguins to examine current efforts to preserve biodiversity in the United States. The paper criticizes the failure of the Endangered Species Act to fully consider the costs of its regulatory mandates, but recognizes the complications of determining and balancing the benefits and costs of biodiversity preservation. The paper examines the Safe Minimum Standard Approach, urged by some economists as an alternative to traditional cost-benefit analysis in contexts such as species preservation, but ultimately rejects it as neither justifiable nor helpful. The paper suggests that domestic biodiversity policy should start by eliminating public subsidies that encourage the economically inefficient destruction of ecosystem components, by finding ways of commodifying ecosystem services, and by establishing a system of taxes and subsidies that send correct economic signals to property owners. Because many of these goals will be politically difficult to achieve at least in the short run, the \"tailored commands\" of the Endangered Species Act will continue to play an important role in protecting valuable species and ecosystems. But incorporation of rough cost-benefit considerations (taking account of uncertainties, irreversibilities, and intergenerational tradeoffs) into the Endangered Species Act would help the nation achieve a more optimal use of its scarce societal resources. An earlier version of this article was announced as Stanford Law School, John M. Olin Program in Law and Economics Working Paper No. 173. The working paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=149728","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"47 2 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"1999-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"84807306","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
In this article we incorporate notions of the fairness of sanctions into the standard model of public enforcement. When both the probability and magnitude of sanctions may be varied, the usual solution involves a very high sanction and a relatively low probability of enforcement if individuals are risk neutral. When the issue of fairness is added to the analysis, the optimal sanction generally is not extremely high because such a sanction would be seen as unfair. The optimal probability of imposing sanctions may be higher than in the usual case (to offset the lower sanction) or lower than in the usual case (because the lower sanction reduces the effectiveness of enforcement).
{"title":"The Fairness of Sanctions: Some Implications for Optimal Enforcement Policy","authors":"A. Polinsky, S. Shavell","doi":"10.1093/ALER/2.2.223","DOIUrl":"https://doi.org/10.1093/ALER/2.2.223","url":null,"abstract":"In this article we incorporate notions of the fairness of sanctions into the standard model of public enforcement. When both the probability and magnitude of sanctions may be varied, the usual solution involves a very high sanction and a relatively low probability of enforcement if individuals are risk neutral. When the issue of fairness is added to the analysis, the optimal sanction generally is not extremely high because such a sanction would be seen as unfair. The optimal probability of imposing sanctions may be higher than in the usual case (to offset the lower sanction) or lower than in the usual case (because the lower sanction reduces the effectiveness of enforcement).","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"75 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"1998-09-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"90058414","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
This paper addresses the implications of the Theory of the Second Best for law and economics scholarship. The theory of the second best is at once fascinating and paralyzing. Fascinating because it so powerfully assaults much of modern economic theory; paralyzing in that it does not offer a clear replacement for what is purports to destroy. Dick Markovits, who has done so much to keep this important theory in the minds of law and economics scholars, gives an example that suggests the difficulty: a tort doctrine is implemented which compels manufacturers to pay the cost imposed by their discharge of pollutants into any body of water. At first blush, the policy change seems unambiguously good. Prior to the doctrinal change, manufacturers who dumped noxious chemicals and metals into bodies of water created "externalities", social costs that they imposed with impunity. As a result, a manufacturer would maximize profits by discharging pollutants whenever there was even the slightest benefit in so doing. In other words, instead of providing an incentive to promote the public good, the presence of large external costs in a market system encourages undeniably harmful activity. It would seem that eliminating this perverse incentive could only be beneficial, and, at least in the absence of the theory of the second best, this logic would be unassailable. But once the disruptive theory of the second best is introduced, all bets are off unless there happens to be no other distortion in the economy, a most unlikely event. The paper examines a variety of applications of the theory, including a paper by Fullerton and Metcalf that demonstrates that many scholars have been unduly optimistic in asserting that pollution taxes will yield the double dividend of a better environment and more tax revenues with less deadweight loss. In so doing, Fullerton and Metcalf have certainly diminished the prospect, advocated by some, that excess pollution taxes will be imposed to reduce the deadweight loss from distortionate labor taxes. Their paper also shows, however, that, as between the competing policies of the pollution tax or the pollution quota, the former is clearly preferable. Since Fullerton and Metcalf also demonstrate why business strongly prefers the quota to the tax, we may have our own ironic version of the second best in operation here. Three states of the world are plausible: 1) the overtaxation state that Fullerton and Metcalf attack; 2) the precise Pigovian tax rate that they presumably endorse; and 3) the command and control regulation (the undertaxation state) that business so strongly prefers. Since the pressures of special interests have clearly biased policy towards state (3), arguments in favor of position (1) might have corrected the political imbalance, thereby making position (2) more likely. Now that Fullerton and Metcalf have strongly denounced position (1), the counterbalance to the special interest bias towards state (3) is removed, making (3), th
{"title":"Some Thoughts on Law and Economics and the Theory of Second Best","authors":"J. Donohue","doi":"10.2139/ssrn.168612","DOIUrl":"https://doi.org/10.2139/ssrn.168612","url":null,"abstract":"This paper addresses the implications of the Theory of the Second Best for law and economics scholarship. The theory of the second best is at once fascinating and paralyzing. Fascinating because it so powerfully assaults much of modern economic theory; paralyzing in that it does not offer a clear replacement for what is purports to destroy. Dick Markovits, who has done so much to keep this important theory in the minds of law and economics scholars, gives an example that suggests the difficulty: a tort doctrine is implemented which compels manufacturers to pay the cost imposed by their discharge of pollutants into any body of water. At first blush, the policy change seems unambiguously good. Prior to the doctrinal change, manufacturers who dumped noxious chemicals and metals into bodies of water created \"externalities\", social costs that they imposed with impunity. As a result, a manufacturer would maximize profits by discharging pollutants whenever there was even the slightest benefit in so doing. In other words, instead of providing an incentive to promote the public good, the presence of large external costs in a market system encourages undeniably harmful activity. It would seem that eliminating this perverse incentive could only be beneficial, and, at least in the absence of the theory of the second best, this logic would be unassailable. But once the disruptive theory of the second best is introduced, all bets are off unless there happens to be no other distortion in the economy, a most unlikely event. The paper examines a variety of applications of the theory, including a paper by Fullerton and Metcalf that demonstrates that many scholars have been unduly optimistic in asserting that pollution taxes will yield the double dividend of a better environment and more tax revenues with less deadweight loss. In so doing, Fullerton and Metcalf have certainly diminished the prospect, advocated by some, that excess pollution taxes will be imposed to reduce the deadweight loss from distortionate labor taxes. Their paper also shows, however, that, as between the competing policies of the pollution tax or the pollution quota, the former is clearly preferable. Since Fullerton and Metcalf also demonstrate why business strongly prefers the quota to the tax, we may have our own ironic version of the second best in operation here. Three states of the world are plausible: 1) the overtaxation state that Fullerton and Metcalf attack; 2) the precise Pigovian tax rate that they presumably endorse; and 3) the command and control regulation (the undertaxation state) that business so strongly prefers. Since the pressures of special interests have clearly biased policy towards state (3), arguments in favor of position (1) might have corrected the political imbalance, thereby making position (2) more likely. Now that Fullerton and Metcalf have strongly denounced position (1), the counterbalance to the special interest bias towards state (3) is removed, making (3), th","PeriodicalId":90732,"journal":{"name":"Stanford technology law review : STLR : an online high-technology law journal from Stanford Law School","volume":"26 1","pages":""},"PeriodicalIF":0.0,"publicationDate":"1998-02-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"84158445","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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