A Critique of the Odious Debt Doctrine

Choi and Posner indicate that it is unclear whether the doctrine will improve the welfare of the population that might be subject to a dictatorship in terms of the odious debt doctrine. The traditional backward-looking defense of the odious debt doctrine, which suggests that the doctrine is costless because it releases a suffering population from an unjust debt, is seriously incomplete. Although in specific cases the benefits of loan sanctions may exceed the costs, the defenders of the doctrine have not made the empirical case that the net benefits are sufficiently high in the aggregate as to warrant routine application of loan sanctions to odious dictators. Therefore, in the absence of such a showing, there is no reason to think that the odious debt doctrine would be a desirable rule of international law

Deal Protection Devices

In mergers and acquisitions transactions, a buyer and a seller will often agree to contractual mechanisms (deal protection devices) to deter third parties from jumping the deal and to compensate a disappointed buyer. With the help of auction theory, this Article analyzes various deal protection devices, while focusing on the two most commonly used mechanisms: match rights and target termination fees. A match right gives the buyer a right to “match” a third party’s offer so as to prevent the third party from snatching the target away, while a termination fee compensates the buyer when a third party acquires the target. Such mechanisms raise a number of important corporate and contract law questions. How effective are they in preventing third parties from competing for the target? Do they steer the target to be sold to a buyer who values the target less? Are the devices harmful to the target shareholders? To what extent can the negotiated deal price represent the target’s “fair value” when such devices reduce or eliminate the competition? This Article shows, foremost, that these devices can actually increase the target and buyer’s joint return and possibly the target’s stand-alone return. Match rights and termination fees function quite differently, however. While a large termination fee reduces the target’s stand-alone return and can lead to allocative inefficiency, an unlimited match right increases the target’s stand-alone return and promotes allocative efficiency. This Article argues that answering the corporate law questions ultimately turns on the question of how and why the target directors are utilizing the devices. If the devices are being deployed with the objective of maximizing the target shareholders’ return, not only can they be beneficial for the target shareholders, but their presence can also make the deal price a more reliable indicator of the target’s fair value. With an improper objective, not only do the devices undermine target shareholders’ return, but the court also should not use the deal price as evidence of fair value. This Article also analyzes stock and asset lockups and examines deal protection devices through the lens of contract law

Initial Public Offering and Optimal Corporate Governance

This paper examines the long-standing debate over whether firms have a market-based incentive to adopt optimal governance provisions at their initial public offering (IPO). Various scholars and practitioners have argued that firms that offer stock to the public with suboptimal governance structure will be penalized by the market through a lower IPO price. At the same time, others have documented empirical evidence that many IPO firms have putatively suboptimal governance provisions, such as anti-takeover provisions and dual class structure, and many, especially those with dual-class structure, enjoy a market premium at their IPO. This paper attempts to bridge this gap. The paper’s main argument is that when different firms have different sets of optimal governance features (firm heterogeneity) and the investors have incomplete information on which governance features are optimal for which firms (informational issues), it becomes likely that the IPO process will not accurately price the governance arrangements. Due to such market failure, the incentive to adopt the (firm-specific) optimal governance provisions will diminish and firms with similar visible characteristics can adopt similar governance features even though they may be suboptimal for some firms. After presenting the baseline thesis, the paper examines various private ordering and regulatory mechanisms that could mitigate this market failure, such as a verification using a costly underwriter, more reliance on internal capital markets, deliberate underpricing, and potential post-IPO liability. The paper also presents some positive and normative implications, such as empirical predictions as to when we may expect to observe better pricing of governance regimes and the proposal over sunset provisions on dual class stock structure that convert dual-class to single-class stock after the IPO

Designing and Enforcing Preliminary Agreements

Preliminary agreements—variously labeled as memoranda of understanding, letters of intent, term sheets, commitment letters, or agreements in principle—are common in complex business transactions. They document an incomplete set of terms that the parties have agreed upon, while anticipating further negotiation of the remaining provisions. They often create legal obligations, particularly a duty to negotiate in good faith. This duty has been the subject of a substantial number of judicial opinions over the past few decades and yet continues to be regarded as a confusing and unpredictable issue in contract law. Legal scholarship is hamstrung in its analysis of the case law because it has focused on only one purpose for this good faith duty: protecting the parties’ reliance investments in the bargaining process. This Article broadens the analysis by introducing multiple goals that parties may seek in imposing legal obligations on their negotiation process and by shifting the focus to what the courts have identified as a necessary feature of the duty to negotiate in good faith: the expectation of some fidelity to the agreed-upon terms specified in the preliminary agreement. The ease with which the parties may deviate from these terms in their negotiations is the essence of the good faith standard. Once parties have searched for and chosen their respective contracting partner, they need the incentives and flexibility to tailor and optimize the terms of their deal while also efficiently constraining value-claiming behavior and allocating exogenous risks. The recognition of such broader objectives (beyond protection of reliance investments) allows us also to justify how and why courts are willing to enforce the obligation with the more robust remedy of expectation damages instead of the reliance damages that are advocated by prior scholarship. We show that, by choosing whether to agree to a duty to negotiate (in good faith or otherwise) and by selecting the appropriate damages measure, the parties can achieve the desired level of “stickiness” while addressing concerns about the uncertainty of a flexible legal standard such as good faith

Contract Design when Relationship-Specific Investment Produces Asymmetric Information

Under conventional contract theory, contracts may be efficient by protecting relationship specific investment from holdup in subsequent (re)negotiation over terms of trade. This paper demonstrates a different problem when specific investment also provides significant private information to the investing party. This is fairly common: for example, a manufacturer invests to learn about its buyer\u27s idiosyncratic needs or a collaborator invests to learn about a joint venture. We show how such private information can lead to subsequent bargaining failure and suboptimal ex ante relationship-specific investment. We also show that this inefficiency is worse if the parties enter into a binding and renegotiable contract to trade before the investment is made. This may explain why some preliminary agreements are expressly nonbinding. Finally, we demonstrate that parties may reduce inefficiency by agreeing to negotiate in good faith or other such knowledge-based provisions, especially when these promises are backed by expectation rather than reliance damages

The Economics of Class Action Waivers

Many firms require consumers, employees, and suppliers to sign class action waivers as a condition of doing business with the firm, and the U.S. Supreme Court has endorsed companies’ ability to block class actions through mandatory individual arbitration clauses. Are class action waivers serving the interests of society or are they facilitating socially harmful business practices? This paper synthesizes and extends the existing law and economics literature by analyzing the firms’ incentive to impose class action waivers. While in many settings the firms’ incentive to block class actions may be aligned with maximizing social welfare, in many other settings it is not. We examine conditions in which class action waivers can compromise product safety, facilitate anticompetitive conduct, and support harmful employment practices. Our analysis delivers a more nuanced, policy-based critique of the recent U.S. Supreme Court cases, highlights several new unresolved issues, and identifies future challenges for legal scholarship to address

Just Say No? Shareholder Voting on Securities Class Actions

The U.S. securities laws allow security-holders to bring a class action suit against a public company and its officers who make materially misleading statements to the market. The class action mechanism allows individual claimants to aggregate their claims. This procedure mitigates the collective action problem among claimants, and also creates potential economies of scale. Despite these efficiencies, the class action mechanism has been criticized for being driven by attorneys and also encouraging nuisance suits. Although various statutory and doctrinal solutions have been proposed and implemented over the years, the concerns over the agency problem and nuisance suits persist. This paper proposes and examines a novel mechanism that attempts to preserve the benefits of the class action system while curtailing its costs: allowing a company’s shareholders to vote on securities class actions. The shareholders can vote on the structural dimensions of securities class actions, e.g., whether to allow class actions at all, limit discovery, impose fee-shifting, etc., before any class action suit has been filed (ex ante voting) or vote to determine the course of a specific class action suit, e.g., whether to terminate or settle a class action (ex post voting). The paper analyzes the conditions under which allowing shareholders to manage and control securities class actions can benefit the shareholders across the board and its potential limitations

Liability for Non-Disclosure in Equity Financing

The paper analyzes the effects of holding firms liable for non-disclosure of material information when raising capital. We develop a model in which a privately-informed entrepreneur can choose to withhold information from prospective investors when issuing and selling stock and the investors can bring suit against the firm ex post for (alleged) non-disclosure. The damage payment received by the investors is partially offset by the reduced value of their equity stake. The analysis shows that the equilibrium depends on, among others, (1) the amount of personal capital the entrepreneur has to commit, (2) the frequency with which the entrepreneur is privately informed (the degree of adverse selection), (3) the size of damages payment, and (4) the cost of litigation. Court errors decrease social welfare by weakening deterrence while litigation costs may increase social welfare by deterring the inefficient types or decrease social welfare through wasteful litigation spending. The effects of liability or class action waivers and holding entrepreneurs personally liable for non-disclosure are also explored, and various normative and empirical implications are discussed

The Economics of Class Action Waivers

Many firms require consumers, employees, and suppliers to sign class action waivers as a condition of doing business with the firm, and the US Supreme Court has endorsed companies\u27 ability to block class actions through mandatory individual arbitration clauses. Are class action waivers serving the interests of society or are they facilitating socially harmful business practices? This paper synthesizes and extends the existing law and economics literature by analyzing the firms\u27 incentive to impose class action waivers. While in many settings the firms’ incentive to block class actions may be aligned with maximizing social welfare, in many other settings it is not. We examine conditions in which class action waivers can compromise product safety, facilitate anticompetitive conduct, and support harmful employment practices. Our analysis delivers a more nuanced, policy-based critique of the recent US Supreme Court cases, highlights several new unresolved issues, and identifies future challenges for legal scholarship

Class Actions and Private Antitrust Litigation

When firms collude and charge supra-competitive prices, consumers can bring antitrust lawsuits against the firms. When the litigation cost is low, firms accept the cost as just another cost of doing business, whereas when the cost is high, the firms lower the price to deter litigation. Class action is modeled as a mechanism that allows plaintiffs and attorneys to obtain economies of scale. We show that class actions, and the firms\u27 incentive to block them, may or may not be socially desirable. Agency problems, settlement, fee-shifting, treble damages, public enforcement, and sustaining collusion through repeat play are also considered