Feb 7, 2011 Caroline Bradley
Natasha Affolder,
The Market for Treaties, 11
Chicago J. Int'l L. 159 (2010), available at
SSRN.
The transnational transmission of risk is increasingly visible as a subject of policy debate, from transnational terrorism to global warming, from food safety to the financial crisis. These risk transmissions involve more fundamental security risks: for example, the global financial crisis has led to violent protests; low-lying states are threatened by rising water levels; populations facing issues of food security also have implications for security and stability more generally. As these risks become increasingly recognized, international and transnational law, and also international standards, are increasingly relevant to US-based businesses. Private firms are affected when states enact and propose rules to address risks to global security, such as the SEC’s recent proposals for disclosures about the use of conflict minerals.
Our standard model of the impact of treaties (and agreements setting non-binding standards such as those developed by the Basel Committee) on non-state actors involves implementation through domestic legislation. However, in this article Natasha Affolder argues that corporations engage with environmental treaty norms in ways that this standard model fails to reflect. Instead, corporations interact with treaty norms directly and via the transnational standard-setting process. Thus, she challenges the traditional model of treaty implementation and the usual separation between public international lawyers and scholars of private governance. At the same time her article has implications for those of us who study the legal environment within which businesses operate, and illustrates a complex set of interactions between governmental and non-governmental bodies around environmental regulation and practices.
Affolder suggests corporations’ interactions with and translations of treaty norms may in fact produce changes in the underlying treaty obligations. In some cases corporate action may undermine treaty commitments:
In translating treaty norms for corporate use, companies cherry-pick among treaty provisions, interpret treaty commitments in their least onerous forms, and obscure the ways in which corporate activities impede treaty implementation by selectively reporting on instances where corporate policies and actions advance treaty norms.
But in some contexts, Affolder recognizes that corporate action may “lead to stronger and deeper implementation of treaty norms.”
The article focuses on environmental treaties, although Affolder suggests that the implications of “corporate channeling of treaty meanings” are broader. She would extend the implications to human rights and labor, and I think that her work is also relevant to financial regulation. The global financial crisis led to new efforts to reform financial regulation among domestic, regional and international policy-makers. The Basel Committee has developed Basel III , the EU is reforming its structures for financial regulation, and the US enacted the Dodd-Frank Act. But financial firms and the trade associations which represent their interests are also involved in developing the new rules, through efforts to lobby across borders, arguing that rules applied in one jurisdiction should not be more onerous than those in others, and through the development of private standards. In October, staff of the IMF wrote that “private sector ownership of the financial reforms will be key to the successful implementation of the new rules”.
Affolder’s article is important, and nuanced. Corporate action in translating and implementing treaty provisions is neither entirely positive, nor entirely negative. Affolder does not offer a new theory — but this is the point: she pushes us to face the complex and multivalent facts about the interactions between business and law in a world of multi-level rules.
Jan 7, 2011 D. Gordon Smith
John Armour et al.,
Law and Financial Development: What We Are Learning from Time-series Evidence (2010), at
SSRN.
In the late 1990s, Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W. Vishny (“LLSV”) launched a research project examining connections between legal rules governing investor protection and economic development. Working on the assumption that legal rules could be measured and quantified, LLSV purported to demonstrate that common law countries were more protective of outside investors – and, thus, more hospitable to economic development – than civil law countries. In the ensuing years, LLSV and other economists have expanded and refined their work, constructing the grandly named Legal Origins Theory, which holds that legal systems are important determinants of economic development. The influence of Legal Origins Theory is not confined to economics journals, but may be seen in policy reforms through the World Bank’s Doing Business reports.
While many legal scholars have dismissed this work because of its naïve assumptions about law and legal change, especially in early papers, a group of legal scholars at Cambridge University – led by Simon Deakin, John Armour, and Ajit Singh – took Legal Origins Theory seriously. Embracing the assumption that legal rules could be measured and quantified (“leximetrics”), the Cambridge Group produced legally sophisticated datasets on shareholder protection, creditor protection, and labor regulation. In Law and Financial Development: What We Are Learning from Time-series Evidence, published as part of a recent symposium on Legal Origins Theory in the BYU Law Review, four members of the Cambridge Group take stock of what we have learned from those datasets and chart some new directions for future research.
Critics of Legal Origins Theory will not be surprised to learn that the Cambridge Group finds little support for the theory in longitudinal data. While shareholder protections and corporate governance standards have been strengthened worldwide – reflecting the efforts of civil law countries to catch up with common law countries – these legal changes have not resulted in more dispersed share ownership and increased stock market activity, as predicted by Legal Origins Theory. According to Armour et al., these considerable legal reforms suggest that “lock-in through legal origin has not been much of an obstacle to the formal convergence of systems.” More importantly, legal reforms have not led to greater economic development. The authors offer alternative interpretations of their results:
One possible interpretation of our results is that a “one size fits all” approach to corporate governance reforms, stressing elements of British and American practice—the role of independent boards and the market for corporate control—may not be working as intended in civilian and developing systems. Another interpretation is that even in the common law world, shareholder protection can have counterproductive effects, by unnecessarily raising the costs associated with a stock exchange listing.
For those who remain interested in attempts to discern connections between law reform and economic development along the lines suggested by Legal Origins Theory, Armour et al. urge a reconceptualization of the role of legal systems: “legal systems are not the independent, ‘exogenous’ force that legal origins theory takes them to be. Legal systems are, to some degree, ‘endogenous’ in the sense of being shaped by their economic and political environment.”
The work of the Cambridge Group is an important part of the most significant research advance on corporate governance since the advent of law and economics in the 1970s and 1980s. The analysis by the Cambridge Group has called into question many of the central tenets of Legal Origins Theory, but in my view, the more important long-term contributions of this work are twofold: (1) the work has gone a long ways toward legitimating “leximetrics” in studies of comparative corporate governance, and (2) the work has reignited interest in comparative corporate governance, a field that has traditionally suffered from a perceived lack of rigor.
This may seem a bit hyperbolic, but I believe that this work has paved the way for a re-examination of the whole of corporate law from an empirical, comparative perspective. Such work requires more resources than the traditional corporate law scholarship, but the Cambridge Group has demonstrated the power of leximetrics to provide new insights. One can imagine using these techniques to compare various states in the U.S. or various countries in Europe along any dimension of law that might possibly be related to economic development.
Nov 5, 2010 Eric Pan
Poor Delaware. The small state (45th in population and 49th in geographic size) is the dominant corporate law jurisdiction in the United States, and for decades the academic community has been fascinated with the reasons why. Initially, scholars portrayed Delaware as the savvy champion of a fierce competition for corporate charters. The quality of its courts, the richness of its case law, and the responsiveness of its legislature made Delaware the most attractive place to incorporate for US public companies. When Marcel Kahan and Ehud Kamar’s wrote The Myth of State Competition in Corporate Law, 55 Stan. L. Rev. 679 (2002), the academic community’s view of Delaware had changed: Delaware was not facing direct competition from other states, but rather winning by default.
More so than any other corporate law scholar, Mark Roe has tried to explain why Delaware still has much to fear. Roe is well known for his argument, articulated in Delaware’s Politics, 118 Harv. L. Rev. 2491 (2005), that Delaware faces a competitive threat from the possibility of corporate governance regulation by the federal government. Roe’s analysis, originally written in the wake of the Sarbanes-Oxley Act of 2002, has proven prescient with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act last July, which introduced a host of significant corporate governance reforms for US public companies, including say-on-pay and proxy access.
Like the Stephen King of corporate law, Roe is now back with a new set of reasons why Delaware should be afraid . . . very afraid. First, armed with data on Delaware’s franchise tax receipts and incorporations by companies into Delaware, Roe presents some striking statistics:
- Every year, Delaware experiences a 10 percent turnover in its list of active firms;
- About 70 percent of Delaware’s active firms incorporated in the state only in the last ten years;
- 54 percent of Delaware’s 2008 franchise tax revenues came from firms that incorporated in Delaware in the past ten years; and
- The amount of time it would take for Delaware to lose half of its franchise tax base (assuming no replacements through new incorporations) has shrunk from 25 years in 1983 to only about ten years in 2008.
Thus, Delaware’s position is precarious. Due to corporate mergers, reorganizations and failures, Delaware’s base of firms decreases at a steady rate. In order to maintain franchise tax receipts at current levels, Delaware must constantly convince new and existing firms to incorporate or reincorporate in Delaware. This need to attract new business, even in the absence of active competition from other states for these incorporations, is a competitive pressure on Delaware to invest in improvements to its corporate law regime.
Second, Roe notes that the threat of a new entrant into the market for incorporations is enough to keep Delaware on its toes. While no state has the same combination of attractive attributes as Delaware, Roe does note that other states do have “toeholds” that could quickly make them viable challengers to Delaware if an opportunity arose. Roe is fascinated by recent efforts by shareholder activists, like Carl Icahn, to push companies to reincorporate in North Dakota where a lawyer for Icahn and other shareholder activist groups drafted a new corporate law for the state. But even beyond North Dakota, other toeholds include those states that are developing quite sophisticated jurisprudence regarding the governance of non-corporate business entities and New York with its commercial court system.
Finally, Roe returns to his old theme of the threat posed by federal agencies expanding their efforts to make corporate law.
Roe’s portrayal of North Dakota and other states quietly waiting for Delaware to stumble before making their move would normally generate skepticism. As Lucian Bebchuk, Assaf Hamdani and others have noted before, the barriers to entry for states to enter into a market for corporate charters are quite high. But what makes the threat more serious is Roe’s data on reincorporations and the half-life of Delaware franchise tax base. I do not believe that anyone, other than perhaps those who work for the Delaware Secretary of State, realized how much Delaware relies on a constant flow of new incorporations. As franchise taxes fund a remarkable 17 percent of the its budget, Delaware cannot afford to let this revenue stream end.
The implication is that Delaware is on the defensive. Its priorities lie in preventing other jurisdictions from developing advantages that could draw away new incorporations, and there is no incentive for Delaware to go out on a limb with new reforms that could alienate either the corporate managers who make the reincorporation decisions or the institutional investors who may escalate efforts to avoid Delaware. For those of us who have been critical of various aspects of Delaware corporate law (see, e.g., my paper on problems with the Delaware duty to monitor, available at SSRN), the lesson appears to be to effect change from the outside. Having federal agencies or other state courts and legislatures consider certain corporate governance reforms may be the best way to get the attention of the Delaware legislature and courts.
Sep 7, 2010 Anna Gelpern
Jeffrey Sklansky,
The Moneylender as Magistrate: Nicholas Biddle and the Ideological Origins of Central Banking in the United States, 11
Theoretical Inquiries in Law No. 1, Article 12 (2010), available at
BePress.
I signed up for the August review slot before considering the August mindset. Several things about August make it ill-suited to reviewing: summer is gone, May ideas have hit the wall, and Congress picked July to pass a law that is too-hard-to-teach but too-big-to-skip. I yearn for holiday fun, theoretical breakthrough, and instructional clarity, combined. And I happen on last winter’s symposium in Theoretical Inquiries in Law, Money Matters: The Law, Economics, and Politics of Currency, and historian Jeffrey Sklansky’s article on Nicholas Biddle, President of the Second Bank of the United States.
The volume is part of a wave of crisis-inspired scholarship that is helping fill the wide and widely-acknowledged gap in legal treatments of macroeconomics and finance. This lot stands out for its thorough interdisciplinarity, its thematic coherence, and the gratifying match between what it promises and what it delivers. Contributions from law, economics, history, sociology, and political science are all at impressive levels, but more importantly, they work well together while exploiting the particular advantage of each discipline. Although none offers a grand legal theory of money or a spell to stop crises, together, the articles begin to tease out a picture of the law’s role in constructing money at the intersection of public and private credit, domestic and international regulation—exposing the political, contingent, and instrumental character of money law, even as they highlight the power of legal ideas and techniques.
For an article to shine in this group, it helps to have a colorful protagonist. Biddle served as President of the Second Bank for sixteen years beginning in 1823 (four years after McCulloch v Maryland), and led its losing battle with Andrew Jackson. He was also a litigator specializing in “international debt-collection,” a legislator, a bureaucrat, a poet and an editor. He edited, among other things, a digest of commercial laws of the United States’ major trading partners, Lewis and Clark’s journals, and a literary weekly. And he graduated from Princeton at 15.
Like its talented subject, Sklansky’s piece moves easily among history, law, economics, architecture, politics and literature. Morsels of Biddle’s poetry, his part in fueling the Greek revival, and the contemporary political uses of Mary Shelley’s Frankenstein are enjoyable and rewarding, more for the way the author combines them to frame Biddle’s civic vision in context:
[I]n the solid geometry of pillars and planes, Biddle found an analog for his notion of banking as the poetry of capital, distilling the Platonic ideals concealed within the hustle and bustle of market relations.
Then there is the theoretical insight. In mapping its lawyer-subject’s worldview, the article hits on what I think is still the core legal challenge of central banking: steering aggregate economic activity through the medium of individually regulated financial institutions, while maintaining both technocratic autonomy and political legitimacy. Decades before federal paper money took hold, Biddle headed a hybrid institution that was quite unlike today’s Federal Reserve. Yet he too grappled with a fast-growing gaggle of money-printing private banks, which he sought to control and whose actions reflected back on him with real estate bubbles, financial crises, and urgent demands for public accountability.
Biddle’s conceptions of monetary policy and regulation projected nationalist ambition rooted in international trade and debt experience; they were global to begin with, and from the start, appeared to struggle with the relationship between finance and the real economy. Biddle’s answer to the accountability challenge, in Sklansky’s telling, constructed the central banker as a public servant autonomous from the markets and politics alike, protecting both from themselves and each other, and legitimate thereby. (Curiously, this was similar to his vision of the lawyer.) Whether it is compelling or delusional is beside the point; we are still arguing about central bank independence and regulatory capture with lawyers under-represented in the debate.
Biddle is a famous guy and I am not a Biddle buff, so have limited capacity to assess Sklansky’s contribution to the Biddle canon. However, in my August moment, this historian gave me food for thought on framing legal approaches to central banking. Seeing as I have been looking for a while, and as the Fed did rather well in the recent financial overhaul, I am very grateful.
***
Separately and in brief, do not miss Marcus Miller and Joseph Stiglitz on macro-bankruptcy, or “Super Chapter 11.” They started this project after the Asian financial crises in the 1990s, and have recently published the latest iteration. Then and now it is hardly pragmatic, but important for forcing us to face the logical implications of deploying bankruptcy in a financial crisis.
Cite as: Anna Gelpern,
August Thoughts on Central Banking, JOTWELL
(September 7, 2010) (reviewing Jeffrey Sklansky,
The Moneylender as Magistrate: Nicholas Biddle and the Ideological Origins of Central Banking in the United States, 11
Theoretical Inquiries in Law No. 1, Article 12 (2010), available at BePress),
https://corp.jotwell.com/august-thoughts-on-central-banking/.
May 14, 2010 Bill Bratton
Jeffrey N. Gordon and Christopher Muller,
Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management, Columbia Center for Law and Economic Studies Working Paper No. 369, available at
SSRN; Adam Levitin,
In Defense of Bailouts, 99
Geo. L.J. (forthcoming 2011), available at
SSRN.
The Goldman Sachs circus currently playing Washington certainly is energizing. And it’s a relief to see some life in the legislative process looking to financial reform. But the policy posturing is starting to get to me. Are you, like me, tired of all the claptrap? For a restorative, take out Jeffrey N. Gordon and Christopher Muller, Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management.
Gordon and Muller offer a learned, yet quite readable review of the financial crisis. I particularly recommend their treatment of the role played by credit default swaps and their recounting of the steps that ended in the TARP and the role played by Federal Reserve Act section 13(3) in the sequence of events. The authors know their economics, but in this paper the legal perspective dominates to the reader’s great benefit. There is also a clear-eyed and reasonable analysis of the policy choices. Here Gordon and Muller clear up much of the murkiness that surrounds discussions of “resolution authority.” That accomplished, they suggest that we get used to the prospect of future bailouts. Where a $50 billion fund raises hackles on the Hill, they think $1 trillion is more like it.
If, after reading and assimilating Gordon and Muller, you are ready for something a little more over-the-top, pick up my Georgetown colleague Adam Levitin’s In Defense of Bailouts. Levitin is on the same page as Gordon and Muller and sees bailouts in the cards of whatever future hand we deal ourselves. He makes a stand up case for them on distributive grounds, also showing us where we can expect regulation to succeed and where its likely to come up short. The best stuff is at the end of the paper, where Levitin suggests how to structure bailouts better. Their incidental beneficiaries (read Goldman) should be made to give back once the crisis passes, either through recoupment taxes or returns to the government on force-placed investments.
I’m still worried about the Senate bill. But papers like these somehow make me feel better about it all.
The Goldman Sachs circus currently playing Washington certainly is energizing. And it’s a relief to see some life in the legislative process looking to financial reform. But the policy posturing is starting to get to me. Are you, like me, tired of all the claptrap? For a restorative, take out Jeffrey N. Gordon and Christopher Muller, Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management.
Gordon and Muller offer a learned, yet quite readable review of the financial crisis. I particularly recommend their treatment of the role played by credit default swaps and their recounting of the steps that ended in the TARP and the role played by Federal Reserve Act section 13(3) in the sequence of events. The authors know their economics, but in this paper the legal perspective dominates to the reader’s great benefit. There is also a clear-eyed and reasonable analysis of the policy choices. Here Gordon and Muller clear up much of the murkiness that surrounds discussions of “resolution authority.” That accomplished, they suggest that we get used to the prospect of future bailouts. Where a $50 billion fund raises hackles on the Hill, they think $1 trillion is more like it.
If, after reading and assimilating Gordon and Muller, you are ready for something a little more over-the-top, pick up my Georgetown colleague Adam Levitin’s In Defense of Bailouts. Levitin is on the same page as Gordon and Muller and sees bailouts in the cards of whatever future hand we deal ourselves. He makes a stand up case for them on distributive grounds, also showing us where we can expect regulation to succeed and where its likely to come up short. The best stuff is at the end of the paper, where Levitin suggests how to structure bailouts better. Their incidental beneficiaries (read Goldman) should be made to give back once the crisis passes, either through recoupment taxes or returns to the government on force-placed investments.
I’m still worried about the Senate bill. But papers like these somehow make me feel better about it all.
Cite as: Bill Bratton,
Banking on Bailouts, JOTWELL
(May 14, 2010) (reviewing Jeffrey N. Gordon and Christopher Muller,
Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management, Columbia Center for Law and Economic Studies Working Paper No. 369, available at SSRN; Adam Levitin,
In Defense of Bailouts, 99
Geo. L.J. (forthcoming 2011), available at SSRN),
https://corp.jotwell.com/banking-on-bailouts/.
Apr 5, 2010 Ezra Mitchell
Peter Conti-Brown,
Scarcity Amidst Wealth: The Law, Finance, and Culture of Elite University Endowments in Financial Crisis. Available at
SSRN.
The question of why universities seem to hoard their endowments had become a Senate-level issue prior to the Panic of 2008, and now that normalcy slowly is returning the issue promises to become a live one again. Simply put, in the years preceding the panic, tax-exempt institutions of higher education appeared to be growing enormous endowments while spending only a tiny proportion of them on their current needs. The issue became more sharply illustrated as, in the face of significant endowment losses during the crisis, elite universities with the highest endowments chose to cut budgets, lay-off employees, freeze hiring and salaries, close libraries, and cancel capital projects, among other measures, rather than maintain their then-current levels of spending, at the same time remaining in possession of endowments that still counted in the billions. Conti-Brown asks why, and gives a deeply thoughtful and creative explanation for the endowment puzzle. His answer: endowment building — the accumulation of wealth for its own sake — has taken its place as one of the missions of the institutions, alongside their pedagogical and scholarly pursuits.
As one might imagine, universities are highly secretive about their endowments, and Conti-Brown has done a good job of obtaining such information as he could, focusing on the universities with the five highest endowments: Harvard, Yale, Princeton, Stanford, and MIT. Important among this is that despite the average 30% drop in endowments at these schools (an assumption Conti-Brown makes based on the data he has), endowments remained at the same levels they had attained in 2005 and 2006. Thus the budget cuts seem all the more puzzling and the plot thickens.
The main portion of the article consists of Conti-Brown thoughtfully and systematically debunking the principal theories which have been put forth to justify the accumulation of large endowments (he more modestly puts it that these explanations are incomplete). These include the argument that universities spent unsustainable amounts of money during prosperity and thus had to make significant adjustments when the values of their endowments fell, that legal restrictions on endowment spending prohibited these universities from making up the shortfall out of endowments, and that new styles of endowment investment resulted in the substantial illiquidity of endowment funds, making their use prohibitively expensive or impossible when the crisis hit. The more plausible explanation, as he shows, is that size matters to universities or, as he delicately puts it, “universities’ endowments are like a cowboy’s belt buckle: the bigger the buckle, the more impressive the cowboy.” Elite universities, in this age of rankings, use the size of their endowments as a signal of their superiority to other universities. Seen as such, maintaining the size of an endowment becomes a critical part of the university’s mission.
Conti-Brown’s analysis is careful, and his understanding of the cultural imperative that has driven economic decisionmaking is both persuasive and original. The writing is lively and engaging, and provides an important challenge to universities’ self-justifications for their actions at the same time that it questions the justification of the substantial tax breaks that allow those endowments to grow. If further proof were needed that the issue is alive and important, consider the following:
On February 1 of this year, The New York Times reported that the interim president of Williams College (full disclosure, this commentator’s alma mater) announced that Williams was eliminating its recently enacted program of providing loan-free financial aid to needy students due to a $500 million drop in endowment (which still remained at a rather healthy level of $1.4 billion for a college of approximately 2,000 students). The president was quoted as saying: “Williams is in a strong financial situation by virtually any comparison — except with the Williams of three years ago.” The decision to end a financial aid program that has widely been lauded in order to save $2 million over four years instead of spending more from the endowment, together with the president’s explicit comparison of (recent) past and present endowment size rather than attention to the current size of the endowment in relationship to Williams’ financial needs, may be all the proof the Conti-Brown needs to be assured that he is on the right track.
This is a piece well worth reading, and is rich and deep in a way that raises even more questions about the issue that I hope will be addressed by future scholars who will be indebted to Conti-Brown for his excellent work.
Jan 14, 2010 Robert Ahdieh
Eric L. Talley,
On Uncertainty, Ambiguity, and Contractual Conditions,
34 Del. J. Corp. L. 755 (2009),
available at SSRN.
It may be characteristic of the human condition generally, as much as complex transactions particularly, that we don’t sweat the details.
It should come as little surprise, then, that even parties to significant commercial contracts, drafted by able counsel, are often caught on the shoals of boilerplate terms that received something less than their full attention at the time of drafting. In an area of interest to me, for example, sovereign debt contracts drafted over the last century routinely included so-called pari passu clauses–that is, until Peru’s otherwise unremarkable debt restructuring in 1997 was stymied by a New York-based vulture fund that sought full payment on its bonds, based on that theretofore mysterious provision.
Amidst the recent financial crisis, firms have been forced to face similar questions about boilerplate force majeure provisions – “material adverse change” and/or ”material adverse event” clauses–buried in their contracts. Scholarly interest has followed, including a particularly notable recent contribution by Eric Talley.
In On Uncertainty, Ambiguity, and Contractual Conditions, Talley uses MAC/MAE clauses–as well as the recent analysis of them by the Delaware Court of Chancery, in Hexion v. Huntsman–to reflect broadly on the distinction between risk and uncertainty, and on importance of attending more closely to the latter in contract design and interpretation, whether in corporate settings or elsewhere. Building on this foundation, in turn, Talley offers an empirical analysis of MAC/MAE provisions in recent merger agreements, finding a correlation between changes in the level of ambient uncertainty, and the scope of MAC/MAE provisions incorporated into relevant contracts.
The distinction between risk and uncertainty, as Talley notes, is most commonly traced to the work of Frank Knight, almost a century ago. In Risk, Uncertainty and Profit, Knight first highlighted the distinction between risk and uncertainty, suggesting that where the probability of a random occurrence is unknown, relevant actors are faced not simply with risk, but with uncertainty as well.
More tangibly, one can see the distinction between risk and uncertainty at work in the famous thought experiment devised by Daniel Ellsberg–yes, that Daniel Ellsberg–in his 1961 article, Risk, Ambiguity, and the Savage Axioms. Ellsberg thus suggested offering a given subject the choice of picking a ball from one of two (opaque) urns, in the first of which there are fifty blue balls and fifty red balls, while in the second, there is some random distribution of a hundred balls. The subject is promised a reward, further, if she should select a blue ball. Faced with this choice, Ellsberg suggested, individuals can be expected to prefer the first urn over the second one. Yet more suggestive of the distinct impact of uncertainty, Ellsberg posited that even were the rules altered mid-stream, to offer the very same subject a reward for selection of a red ball, she would continue to prefer the urn containing the known distribution of blue and red balls. (Subsequent experimental evidence, it bears noting, has largely confirmed Ellsberg’s conjecture.)
Perhaps most familiarly–for its recency, if not otherwise–Talley cites Donald Rumsfeld’s famous contrast between “known unknowns” and “unknown unknowns” as suggestive of the distinction between risk and uncertainty. At least as I understand Rumsfeld’s point, however, I am less sure of the analogy. Rumsfeld’s concern would thus seem to be grounded in the question of what we do and do not know, rather than in the nature of what we don’t know. Putting it more precisely, the uncertainty of interest to Talley is that which might influence our expected utility curve. An unknown unknown, on the other hand, would seem by definition to be excluded from the latter–unless, that is, we are to understand our mere awareness of the existence of unknown unknowns to function as an independent determinant of our utility.
In any case, Talley’s reference to Rumsfeld’s now famous remark helps to highlight the importance of attending to the distinct phenomenon of uncertainty, and more carefully evaluating its nature and implications, in various realms of decision-making. In the financial and insurance markets, in mergers and acquisitions, in the fostering of innovation, and elsewhere, it seems likely to be important for us to better understand the nature of uncertainty–just as we already understand risk.
We might, for example, do well to think about the distinct dynamics of uncertainty, across different substantive settings. On financial markets (and similarly thick markets), for example, one might imagine that the assumption of market efficiency (even if only of the mildest form) would generate particular, and perhaps relatively more targeted, patterns of uncertainty. By contrast, in a single-shot setting, perhaps with an unknown counterparty–the purchase of an existing home or used car, for example–we might expect the nature of relevant uncertainty to be relatively more diffuse.
Notably, Talley offers some insight into this question, in conjunction with his empirical assessment of Ron Gilson and Alan Schwartz’s distinct, moral hazard/synergy account of MAC/MAE clauses in merger agreements. In high technology deals, Talley suggests, the degree–and perhaps the nature, I would add–of uncertainty may be different, given the greater proportion of firm value likely to lie in intangible assets.
One might also think about the nature of uncertainty, with reference to the counterpoise of diversifiable and undiversifiable risk. Plausibly, one might think about the latter as taking on some–though perhaps not all–of the characteristics of uncertainty. Diversifiable risk might thus be thought to implicate risks of which the probability is “known,” at least across the entire universe of firms within a given sector. Market risk, by contrast–as perhaps suggested by the recent financial crisis–can be understood as relatively more “unknown” in terms of its probability.
An interest in multiple equilibrium dynamics, finally, leads me to wonder whether certain occasions for uncertainty, perhaps including the mergers context explored by Talley, might be characterized by punctuated equilibria of a sort. As in multiple equilibria settings such as the bank runs modeled by Diamond and Dybvig, we might sometimes expect uncertainty not to be evenly distributed over a relevant range, but instead to exist as between two or more particular equilibrium points. Uncertainty might thus be seen as clustered around a handful of possibilities–whether because the relevant probabilities are, in fact, distributed in that fashion, or alternatively because of a cognitive bias toward thinking in those terms, rather than in the manner predicted by Savage’s subjective expected utility framework (as outlined by Talley), in which consistent probabilities are assigned to each and every potential outcome.
Beyond such questions about the nature of uncertainty, Talley’s empirical analysis of MAC/MAE clauses also sparked my interest for the questions it raises about the nature of contract boilerplate in sophisticated contracts, an issue I have previously explored.
Perhaps most importantly, I wondered about Talley’s decision to calculate the strength of MAC/MAE provisions in relevant contracts by simply counting the number of said provisions in each contract. As Claire Hill and others have suggested, the drafting of complex commercial contracts may, as often as not, be characterized by a kind of one-way ratchet. In this account, risk-averse lawyers (often junior associates in large law firms) incorporate a succession of new terms from one contract to the next–whether in the face of new issues, or simply because they hear that others are doing so. By contrast, they never delete old ones, for fear of potential unintended consequences, for which they–having removed the relevant provision–will end up being blamed.
In the presence of such a dynamic, a mere count of MAC/MAE provisions has the potential to prove misleading, as one would expect greater friction in the downward versus the upward movement of the number of relevant terms. Further, one would not expect the quantity of relevant terms to be evenly distributed over the relevant range. Rather, one might expect to see patterns of exponential rather than arithmetic growth in the number of terms, as the presence of any given number of provisions fosters the addition of more.
This possibility, in turn, raises the related question of who exactly determines to incorporate MAC/MAE provisions of one scope or another, in the first place. In the latter account of contract drafting, of course, it is the attorneys who do. Likewise, in the development of sovereign debt contracts: Thus has the empirical analysis of Stephen Choi and Mitu Gulati identified repeat-player attorneys for issuers as the primary determinants of innovation in sovereign debt contract instruments.
Coming back to where we started, though, one might plausibly surmise that no one at all is paying much attention to MAC/MAE and other boilerplate provisions in complex contracts, in the absence of some pressing impetus for them to do so. Useful data to this effect might well be generated over the ensuing months; it would be helpful, thus, to see how the scope of MAC/MAE provisions does (or does not) change over the year ahead, as the level of uncertainty necessarily declines. For the moment, however, it remains at least plausible that contract provisions on uncertainty truly are unknown unknowns–as terms that simply do not get the attention they deserve, until crisis is already upon us.
Cite as: Robert Ahdieh,
Unknown Unknowns: Uncertainty, Contracts, and Crisis, JOTWELL
(January 14, 2010) (reviewing Eric L. Talley,
On Uncertainty, Ambiguity, and Contractual Conditions,
34 Del. J. Corp. L. 755 (2009),
available at SSRN),
https://corp.jotwell.com/unknown-unknowns-uncertainty-contracts/.
Nov 23, 2009 Caroline Bradley
Kenneth A. Bamberger, Technologies of Compliance: Risk and Regulation in a Digital Age, 88 Tex. L. Rev. (forthcoming 2010), available at SSRN. The global financial crisis raises profound questions about how financial markets and the participants in those markets should be regulated. The scale of the crisis has meant that issues which are normally discussed only by technical experts now are the subject of public debate. However, much of this public debate (and even some academic debate) about the future of financial regulation seems to assume that introducing a few new national and transnational institutions and changing a few rules can make a significant difference. For this reason, Kenneth Bamberger’s article, Technologies of Compliance: Risk and Regulation in a Digital Age, forthcoming in the Texas Law Review, is essential reading. The article shows that it is necessary to think about the ways in which private and obscure technologies of compliance risk distorting financial regulation.
Over the last few years, and somewhat ironically given the crisis, financial regulation has evolved to emphasize risk management by financial firms. Regulators have identified many varieties of interconnected risks which financial firms should manage. But although the crisis illustrates weaknesses in how financial firms have in fact managed the risks involved in their businesses, risk management as a focus of regulation is clearly here to stay. The G20, most recently in the Leaders’ Statement from the Pittsburgh Summit, and the Basel Committee (for example in its revisions to the Basel II market risk framework) continue to emphasize the idea of risk management as a core component of financial regulation. Policy makers are advocating the development of more sophisticated domestic and transnational institutions for the management of systemic risk.
The complexities of large financial corporations and financial regulation are such that modern risk management is necessarily a zone of automation. Transnational systemic risk management is also likely to involve automated systems. But although some of the critiques of the financial regulatory system in which the crisis was born, such as the UK’s Turner Review, note that regulators had acquiesced in the market’s over-reliance on complex mathematical models for risk management (in particular in the context of capital adequacy), the larger debate around financial regulation tends to be innocent of the complexities of compliance. By unpacking some of the layers of financial regulation, Bamberger provokes his readers to think carefully about the implications of the use of automated compliance systems for risk management.
Programmers who develop automated compliance systems, Bamberger argues, effectively make choices about how to interpret the law, and how to translate it into code. The law as applied may be different in important ways from the law that legislators and regulators promulgated — not least because the regulators’ choices to emphasize principles rather than rules are subverted by an implementation which turns principles into rules. Not only is law modified through the actions of managers of financial firms in applying it, but it is modified, perhaps in ways not fully understood by managers, by the programs which are used to apply it. Bamberger describes the processes which generate compliance systems as involving interactions between separate expert systems which communicate with each other imperfectly. The resulting risk management systems are ultimately a source of risk.
In contrast to public processes for the development of laws and regulations, the processes which generate compliance systems are private and opaque. Bamberger argues that choices about the interpretation of law should not be made by “private third-parties invisible to regulators.” He asks: “how does the technological instantiation of law-elaboration through implementation fare in light of the public law norms of accountability, effectiveness and legitimacy that traditionally govern the exercise of delegated discretion?”
Bamberger thus shows us that automated compliance systems are problematic from the perspective of genuine risk management and also from the perspective of good governance. The solutions he proposes for both sets of problem involve increasing transparency and improving the technical expertise of regulators, facilitating a dynamic collaboration of regulators and firms to develop effective risk management systems, including recognizing the importance of human judgment. Bamberger is not the only scholar whose work suggests that corporate lawyers should become more familiar with the implications of new governance scholarship, but his elegant unpacking of the subtle issues involved in automated compliance and the implications of this unpacking for thinking about risk management make this article required reading.
Oct 27, 2009 Bill Bratton
Anna Gelpern,
Financial Crisis Containment, 41
Conn. L. Rev. 1051 (2009). Available at
SSRN.
The financial crisis caught many unawares, and not just in their pocketbooks. Those of us who do corporate law had been operating for ever so long under a paradigm favoring market control of corporate actors. In so doing we familiarized ourselves with the financial economics of market success. Market failure did not escape our view, however. Between the standard objections to law and economics, the tech bubble of the late 1990s, and emerging literatures on behavioral influences on stock prices and pricing under heterogeneous expectations, we spent plenty of time writing about it and debating it. But matters like total or near-total economic collapse and prudential regulation occupied the desks of only a handful of people – specialists on structured finance like Steve Schwarcz and banking experts like Pat McCoy, Dan Tarullo, and Arthur Wilmarth. Lehman and TARP meant that the rest of us had some catching up to do, especially those of us who purport to know about finance.
Since last fall I have read a stack of papers and books about financial crisis, theoretical and historical. Some of this has been old material, old here meaning publication before the fall of 2008, and some of it has been new. But for the aforementioned colleagues, it has been the work of economists.
I would like to take the occasion to note that a new member has joined the small club of legal academic writers who have something to teach us about financial crisis. The writer is Anna Gelpern of American University, and the paper of admission is Financial Crisis Containment, 41 Conn. L. Rev. 1051 (2009), available at http://ssrn.com/abstract=1401062. The thesis is that crisis containment proceeds in a distinct regulatory space. Those who occupy it do not and cannot play by the usual rules. When regulators stand at the precipice and try to get things stabilized, standard concerns like ex ante incentive compatibility, security of contract, moral hazard, and even the liquidity-solvency distinction take the back seat. Gelpern reorients our perspective, coaxing common patterns of response from five past crises – this country in 1933, Mexico in 1982, Japan in the mid 1990s, Indonesia in 1997-1998, and Argentina in 2001-2002. As she does so, she emphasizes political choices and their distributive consequences. The account is refreshing and instructive.
Now, do not pick up this paper looking for the roadmap forward. This is description and typology. But the limits do not matter. It is compelling reading. Some of it is as gut wrenching as financial discourse can get. I found it especially valuable because I read it in tandem with a stack of material that approached the same phenomena within tight methodological boxes or with built in policy agendas. Some papers teach you volumes of what you need to know to formulate sound policy without purporting to dictate policy to you.
Oct 26, 2009 Michael Froomkin
Section Editors
The Section Editors choose the Contributing Editors and exercise editorial control over their section. In addition, each Section Editor will write at least one contribution (”jot”) per year. Questions about contributing to a section ought usually to be addressed to the section editors.
Professor Caroline M. Bradley
University of Miami School of Law
Professor William Wilson Bratton
Peter P. Weidenbruch Jr. Professor of Business Law at Georgetown University Law Center
Contributing Editors
Contributing Editors agree to write at least one jot for Jotwell each year.
Professor Robert B. Ahdieh
Director of the Center on Federalism and Intersystemic Governance at Emory University School of Law
Professor Steven M. Davidoff
University of Connecticut School of Law
Professor Anna Gelpern
American University – Washington College of Law
Professor Joe McCahery
University of Amsterdam, Amsterdam Center for Law & Economics
Professor Lawrence E. Mitchell
Theodore Rinehart Professor of Business Law at The George Washington University Law School
Professor Eric J. Pan
Director of the Samuel and Ronnie Heyman Center on Corporate Governance at
Benjamin N. Cardozo School of Law / Yeshiva University
Professor David Arthur Skeel
S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Law School
Professor D. Gordon Smith
Associate Dean and Glen L. Farr Professor of Law
