Category: Economic Analysis of Law

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Free Cabs, Free Tuition, and the Power of Deregulation

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Yesterday’s NY Times featured an article about a NY cabbie who offers free rides and apparently cleans up on the generous tips. This reminded me of an experiment conducted by NYU Law a couple years back. A cohort of students were admitted for zero tuition with the hope that they would give more generously as alumni (taking advantage of the federal government’s tax deduction subsidy.) This left me wondering: when does this strategy of giving away a product or service ultimately prodcue greater revenue? And relatedly, are there other situations where deregulating behavior – i.e., eliminating a requirement that people behave in some way – might lead to more “good” behavior (defined in the same way as regulators might) on the part of these people.

When does giving away a product produce greater revenue? In the case of the cabbie, I think that people are tipping him beyond the normal fare for a few reasons. First, passengers probably love the choice to pay what they want. They also appreciate the trust he puts in them by allowing them to define the fee. Finally, they probably enjoy the novelty of a free cab ride. My guess is that giving away a product works particularly well where there is a one-on-one relationship between provider and consumer. But perhaps most importantly, the cost of a cab is generally known (most locals probably have an idea of what a meter fare would have been), and that cost is often BELOW actual market value. I can think of many situations – rush hour, rain, etc – in which most cabs could double their fares and still stay full.

The law school give-away offers students one more benefit (beyond choice, trust, and novelty): time. Students have limited income and NYU’s program offered students a chance to pay NYU after the six-figure incomes kicked in. But I wonder if the law school experiment is paying off? I think people over-tip the cabbie because they appreciate what he is doing for them, personally. And in the law school context, we’re not talking about dropping $20 unnecessarily; it takes serious commitment to get an alum to donate $100K (plus interest). Of course, it helps that Uncle Samuel will subsidize that gift.

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Discussion on Payday Lending at the ‘Glom

There is an interesting discussion ongoing at the Conglomerate on the study of payday loans. Ronald Mann, who started the topic, is particularly interested in the interaction between virtual and nonvirtual lenders, and he notes that the e-market offers significantly better rates. Does this discount relate to different costs, or to different income levels? Go check it out.

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Dunbar and Heller on the Future of Securities Class Actions

For those who want background on why Judge Alito’s strong recent re-affirmation the efficient capital markets hypothesis matters, there is a new article on SSRN for you.

Frederick Dunbar and Dana Heller (both of National Economic Research Associates) have posted “Fraud on the Market Meets Behavioral Finance,” forthcoming in the Delaware Journal of Corporate Law. From the abstract:

The efficient market hypothesis, in its current form, dates academically from 1970 and it was first accepted by a Federal Court in a shareholder class action in 1975, providing plaintiffs with a rebuttable presumption of reliance based on the fraud-on-the-market theory. By 1988, the fraud-on-the-market theory was the law in most Circuits and was affirmed by the Supreme Court in Basic v. Levinson. Since then, the efficient market hypothesis has not been rebutted in any case involving actively traded securities, and its impact on securities litigation and regulation extends well beyond class certification to materiality, causation and damages. Somewhat ironically, over the same time period, financial economics was, first, finding anomalies in securities markets that were not consistent with the Supreme Court’s version of the efficient market hypothesis and, second, using concepts borrowed from behavioral economics to develop theories of securities price formation to explain, among other things, the stock price bubble of the late 1990s. In fact, even proponents of the efficient market hypothesis have claimed that securities were mispriced during this episode. If courts were to adopt behavioral finance explanations of securities market behavior, then prior precedent would not be appropriate in a number of areas of securities fraud including reliance, materiality, causation and damages. We explore the implications of how analysis of these issues would be changed by application of behavioral finance.

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David Giacalone on the FTC’s Price Gouging Statement

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David Giacalone has a nice new post up about the FTC’s recent position statement against a federal price gouging law. I had missed this development last week.

According the FTC’s chairperson, “[e]nforcement of the antitrust laws is the better way to protect consumers.”

As a first take, I think I agree that there is no pressing need for yet more federal regulation of economic activity, especially where states are both capable, and in this case motivated, to take care of the “problem” themselves. This is particularly true in this context, where the harms attributed to price gouging are localized and fleeting.

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Becker and Posner Mull Price Gouging

Over at the Becker-Posner Blog, the resident luminaries have gotten around to discussing the problem of whether and when to punish “price gouging” after natural disasters. Judge Posner makes the expected moves (“sheer ignorance of basic economics”; “[t]he only beneficiaries will be people with low costs of time and nonurgent demand”; “higher prices for gasoline are a source of substantial external benefits”.) However, he does concede that price gouging regulations might be appropriate under two types of circumstances.

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Alito: The Business Friendly Justice?

Larry Ribstein has a great new post up on the jurisprudence of Third Circuit Judge Samuel Alito, a potential SCOTUS nominee. He sums up:

In short, Alito has displayed a marked tendency to enforce contracts as written, specifically including choice of law/forum and arbitration provisions that are intended to mitigate litigation costs. He’s also obviously aware of the problems that can be caused by lax proof standards and open-ended liability.

On the list that Prof. Ribstein has created, I was particularly interested in In re Burlington Coat Factories Sec. Lit. Prof. Ribstein says that decision involves a “deni[al] securities claims for failure to adequately allege scienter and materiality, and for lack of a duty to update.” My reading of the decision produced a somewhat more complicated picture, which may give some insights into Alito’s opinions about securities complaints.

First, unlike the district judge whose opinion the Third Circuit was passing on, Alito’s opinion is significantly more respectful of the pleading standard, reversing (in effect) a dismissal on materiality grounds. This decision – if representative of Alito’s larger jurisprudence – suggests that he is not particularly hostile to securities plaintiffs. In the end, the opinion does dismiss claims on 9(B) grounds, but with leave to re-plead.

Most significantly, the Judge appears to buy into the efficient capital markets hypothesis without hesitation, dismissing one claim which failed to result in a market reaction with the following reasoning.

In the context of an “efficient” market, the concept of materiality translates into information that alters the price of the firm’s stock. . . . This is so because efficient markets are those in which information important to reasonable investors (in effect, the market) … is immediately incorporated into stock prices. … Therefore, to the extent that information is not important to reasonable

investors, it follows that its release will have a negligible

effect on the stock price.

There are two basic problems with the idea that non-price-movement should mean immateriality as a matter of law. First, there will be times when market-wide distortions will dampen reaction to disclosures — which is why we require litigants to conduct expensive loss causation analyses which correct for the effect of the market-basket. Second, the behavioral finance literature, summarized by Ribstein (in a great paper) here, should give pause to judges, plaintiffs and others who seek to rely heavily on the ideal of a perfectly well-functioning market. To be fair, we can’t blame Judge Alito for not being aware of this literature back in 1997, but it would be interesting to know what he thinks today.

Needless to say, if I were on the judiciary committee, we’d have fewer questions on intellectually moribund subjects like con law, and many more of the following type(s): “How should judges go about evaluating the question of whether the stock market is fully efficient? Can securities class actions survive evidence of irrational decisionmaking?”

[UPDATE: I've investigated Judge Alito's securities decisions further here.]