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Abstract: The role of intellectual property is examinedand, specifically, patents in the software industry. Especially considered arethe advantages and disadvantages of patents depending on firm size. Findingsare based on interviews with about 60 professionals in the software industry.The interviews elicited information about the motivations, practices, andinstitutional environment of the software industry. The study begins by emphasizing the difficulties that startups haveextracting value from patents. As the firm gets larger, potential benefits frompatents appear. Some startups do have patents strong enough to excludecompetitors, which are often larger firms. Hence, patents are more beneficialto small firms than to large ones. Next is considered the indirect effects dueto the use of patents in cross-licensing transactions for signaling informationabout a firm. The claims that enforcement of software patents has created a patent"thicket" that limits innovation is rejected. Young firm development isnot significantly hindered by large patent portfolios of established firms. Therelatively weak protections that copyright and trade secrets afford areconsidered. Neither usefully allows small firms to obtain value from theirinventions. Conclusions of the study provide skeptical evaluations of severalproposals that would limit patent rights but not completely abolish them.(TNM)
Patent thicket, Protection of investments, Value, Software industry, Trade secrets, Commercialization, Costs, Cross licenses, Innovation process, Intellectual property, Inventions, Patents
Abstract: This paper is the first part of a wide-ranging study of the role of intellectual property in the software industry. Unlike previous papers that focus primarily on software patents -- which generally are held by firms that are not software firms -- this Article provides a thorough and contextually grounded description of the role that patents play in the software industry itself. The bulk of the Article considers the pros and cons of patents in the software industry. The Article starts by emphasizing the difficulties that prerevenue startups face in obtaining any value from patents. Litigation to enforce patents is impractical for those firms. Efforts to obtain patents divert the firms focus from the central task of designing and deploying a product, and the benefits of excluding competitors are limited for firms that cannot themselves exploit the relevant technology. Once the firm is larger, a number of potential benefits appear. First, despite concerns that patents are not effective to appropriate innovation in the software industry, a substantial number of software startups do have patents of sufficient strength to exclude competitors. That important finding, taken with the fact that the principal targets of those patents are much larger firms, suggests patents are more beneficial to small firms than to large firms. The Article then considers indirect effects related to the use of patents in cross-licensing transactions and in providing information about the firm. The first benefit may be substantial to firms that obtain patents, but the Article dismisses use in cross licensing as a net benefit to the industry: absent some other benefit, all firms would be better off saving the costs of obtaining patents. The information benefits, in contrast, seem to be net improvements in the system of innovation. The central question, which I do not attempt to answer here, is whether those benefits are sufficiently substantial to justify the costs of obtaining the patents. The Article then turns to the prominent claims that the enforcement of software patents has hindered innovation in the software industry through creation of a patent "thicket." The Article rejects those claims for two broad reasons. First, notwithstanding the empirical analysis of R&D spending in papers by Bessen, Maskin, and Hunt, direct evidence of high R&D spending in the software industry undermines claims that software patents cause firms to reduce R&D spending. Second, the actual structure and practices of the industry belie any claim of a patent thicket. Relying on interviews that I conducted and publicly available information, I show that the development of young firms in the software industry is not significantly constrained by the existence of large patent portfolios in the hands of incumbent firms. The Article also contextualizes the role of patents by examining the relatively weak protections that copyright and trade secret can afford. At bottom, neither of those systems can provide a useful mechanism that would allow small firms to appropriate the values of their inventions. If such protection is a significant positive benefit of the patent system, it is equally true that neither copyrights nor trade secrets are contributing (or can contribute) significantly in that respect, however useful they might be in other roles (such as preventing piracy). The Article closes by considering critically the possibility of middle-ground responses that would limit patent rights in the industry but not abolish them entirely. First, I criticize a possible registration system that might provide the information benefits discussed in Part III without the costs of excluding competitors. I argue that such an approach would be impractical both because it would be difficult to disentangle the information benefits from the right to control technology and because of my sense that software firms would have an inadequate incentive to participate in such a system. Second, I consider the possibility of special limits on the rights of "trolls," small nonoperating firms formed solely to litigate patents. Trolls serve a useful function as specialized intermediaries and thus in fact may have a positive role in promoting innovation in the industry. Third, I consider the possibility that slight alterations in the patent rules for enablement and disclosure might mitigate the risks that trolls pose to the licensing equilibrium that minimizes the costs of patenting in the software industry.
software, patents, copyright, venture capital, innovation
Abstract: The traditional perspective holds that large firms in our economy use unsecured credit and small firms use secured credit. Existing scholarship has not done much, however, to explain that pattern. In a recent article, I attributed the use of unsecured credit by large firms to the limited ability of secured credit to lower the lending costs of creditworthy companies. This paper builds on data from a series of interviews with small-business bankers to explain the small-business half of the pattern. I argue that the only significant benefit of secured credit for small-business borrowers is that it allows them to give a credible commitment that they will refrain from excessive future borrowing. It provides little in the way of liquidation value, because the assets of small businesses tend to have low liquidation values. Similarly, it does little to improve the borrower's incentives, because the lender can accomplish the same thing by taking a guaranty from the borrower's principal. I then have to explain why so much small-business borrowing is unsecured. I identify four separate effects that support the use of unsecured credit in small-business lending: the relatively high transaction costs of secured debt; the declining enforceability of constraints on future lending (brought on by the ready availability of credit-card debt); the ambiguous value of constraints on future lending; and technological developments in credit-scoring and early-warning systems that reduce lending costs and risks considerably. I argue that those developments presage a marked shift of small-business lending from secured debt to unsecured debt. Finally, I argue that those developments cast doubt on the traditional view that businesses use secured debt as a device for externalizing risk to third parties. The decline of secured debt at a time when legal liability risks appear to be increasing suggests that the transaction costs I discuss are more important to the pattern than the ability to externalize risk that is the focal point of the traditional perspective.
Abstract: Rules governing letters of credit rest on the premise that they provide a highly certain method of payment to a seller of goods. Thus, the law and the terms of the letter of credit make the obligation of the issuer to provide payment to the seller independent of the purchaser?s performance on the underlying contract. Hence, the issuer is obligated to pay the seller upon presentation of specified documents, without regard to the seller?s actual compliance with the contract. In practice, however, most drafts on letters of credit in such transactions do not comply with the letter of credit. To get a sense for the actual rate of compliance, I have collected data on 500 transactions ? 100 each from five U.S.-based banks with large letter-of-credit portfolios. That data shows that the drafts comply in less than 25% of the cases. Thus, a large share of drafts of letters of credit are honored only after the bank consults with the purchaser and obtains the purchaser?s consent to honor the draft. At first glance, that process seems to remove completely the force of the letter of credit, by leaving the seller?s ability to obtain payment to the will of the purchaser. The question, then, is why parties in the industry believe so strongly that the letter of credit operates to provide an enforceably independent payment mechanism for the seller. I bolster the raw data from the transactions with interviews with letter-of-credit executives at those five institutions, as well as interviews with five other banks (two U.S.-based banks and three Japan-based banks) about how they deal with discrepant presentations on letters of credit. The data and interviews show that reputational intermediation provides a significant reason for the letter of credit, entirely separate from any credit enhancement from the bank?s promise to pay. The paper discusses a number of different scenarios, but the most common one is illustrative. In that scenario, an exporter selling goods to a foreign importer obtains a letter of credit issued by a bank in the country of the foreign importer. The willingness of the bank to issue the letter of credit sends a significant signal about the reliability of the overseas buyer. In particular, it suggests implicitly that the buyer is unlikely to respond opportunistically to a discrepant draft on the letter of credit. My interviews with American and Japanese letter-of-credit executives indicate that executives in both countries would terminate relationships with customers ? even profitable customers ? if those customers opportunistically relied on discrepant documents to refuse payment in letter-of-credit transactions. The last question is why the seller chooses to use the foreign bank as an intermediary instead of verifying the reputation of the foreign buyer directly. The answer is that it generally is easier to verify the reputation of a foreign financial institution than a foreign merchant of a more general nature. Most countries have relatively few banks, and very few banks that participate in letter-of-credit transactions. Also, banks are much more likely than other businesses to be sufficiently regulated to ensure the reliability of their public financial statements. In sum, because it is easier for the seller (aided by its own bank in its own country) to assess the reliability of the foreign bank than the reliability of the foreign buyer, the seller uses the foreign bank as a reputational intermediary.
Abstract: This article is an exploration in the tradition of new institutional economics of the possibility that institutional conditions have a significant role in determining the success of credit cards and debit cards. The article examines differences in credit-card and debit-card usage between the United States and Japan. Although I do not doubt that social and psychological factors have some significance, I contend that three institutional factors also have useful explanatory power: the freedom of banks to enter the industry; low telecommunication costs, and the size of the market. The article provides a detailed description of card usage in the two countries, relying on government statistics and the results of a series of interviews with industry executives in both countries. Generally, credit cards in Japan are used for a smaller share of transactions, with a higher average amount, and with less borrowing per transaction. The costs to merchants that take the cards and the rates of fraud also are noticeably higher in Japan than in the United States. The article argues that the difference in usage is attributable primarily to regulations that largely excluded banks and their affiliates from credit-card lending until 1992. For whatever reason, it is clear that the credit card as it exists in Japan is not nearly so useful a product as the credit card in the United States. That explains the smaller rate of usage and the lower borrowing rates. Also, it is to be expected that Japanese consumers would use cash for smaller transactions for which American consumers would use credit cards (which explains the higher average-transaction size in Japan). The article concludes that the differences in discount rates and fraud rates are more likely to be transient, but attributable to a combination of factors, including the comparatively small payment-card market and high telecommunication costs, both of which have hampered the sophistication of responses to fraudulent transactions. Debit cards are used quite rarely in Japan. The first general-use debit card was not introduced until the spring of 2000. Although that card is cheaper for the merchants that take it than credit cards, and also is much more resistant to fraudulent transactions, the article suggests that the debit card will not find as large a market in Japan as it has in the United States. The reason is that the shift of the credit card from its use as a borrowing device here to its use as a near-cash payment device in Japan leaves a much smaller niche for the debit card in Japan.
Abstract: Granting collateral to secure loans is a prominent feature of the U.S. economy, but, surprisingly, we do not understand how borrowers and lenders decide whether to engage in a secured or an unsecured transaction. In this Article, Professor Mann argues that existing theories of secured lending are inadequate because the theories' predictions have not been tested against empirical data. To understand the actual pattern of secured credit, Professor Mann interviewed more than twenty borrowers and lenders in various sectors of the economy. Based on the evidence gathered in these interviews, as well as on preexisting empirical studies, this Article develops a model of the borrower's decision to grant collateral that focuses on the borrower's perceptions of the costs and benefits of secured and unsecured transactions. Granting collateral lowers the aggregate costs of a lending transaction by lowering the pre-loan perception of the risk of default. Secured credit can do this not only by increasing the lender's ability to collect the debt forcibly through liquidation of the collateral, but also in less direct ways: by decreasing the borrower's ability to obtain subsequent loans; by increasing the lender's leverage over the borrower's activities; and by repairing the loan-induced differentiation of the incentives of the borrower and the lender. Conversely, a grant of collateral can increase the costs of a lending transaction by increasing the costs of entering the transaction as well as the costs of administering the loan. In the Article's final section, Professor Mann uses the decision-based model to explain three separate aspects of the pattern of secured credit: the relatively infrequent use of secured credit by companies with strong financial records, the relation between the use of collateral and the duration of the debt, and the apparently low rate of retention of security interests by suppliers.
Abstract: The internet has transformed the economics of communication, creating a spirited debate as to the proper role of federal, state, and international governments in regulating conduct that relates to or involves the internet. Many have argued that internet communications should be entirely self-regulated - either because they cannot or should not be the subject of government regulation. The advocates of that approach would prefer a no-regulation zone around internet communications, based for the most part on the unexamined view that internet activity is fundamentally different in a way that justifies broad regulatory exemption. At the same time, it is undisputed that some kinds of activity that the internet facilitates violate widely shared norms and legal rules. State legislatures motivated by those concerns have begun to respond with internet-specific laws directed at particular contexts, giving little or no credence to the claims that the internet needs special treatment. This Essay starts from the realist assumption that government regulation of the internet is inevitable. Thus, instead of focusing on the naive question of whether the internet should be regulated, it discusses how to regulate internet-related activity in a way that is consistent with approaches to analogous offline conduct. The Essay also assumes that the most salient characteristic of the internet is that it inserts intermediaries into relationships that could be, and previously would have been, conducted directly in an offline environment. Existing liability schemes generally join traditional fault-based liability rules to broad internet-specific liability exemptions. Those exemptions are supported by the premise that in many cases the conduct of the intermediaries is so wholly passive as to make liability inappropriate. We argue that the pervasive role of intermediaries calls not for a broad scheme of exoneration, premised on passivity, but rather for a more thoughtful development of principles for determining when and how it makes economic sense to allocate responsibility for wrongful conduct to the least cost avoider. Accordingly, in cases in which it is feasible for intermediaries to control the conduct, we recommend a framework that pays serious attention to the possibility of one of a series of three different schemes of intermediary liability. The final Part of the Essay uses that framework to analyze the propriety of intermediary liability for several kinds of internet-related misconduct including internet gambling, child pornography, the sale of counterfeit and contraband on the internet, and security harms.
internet, liability, gatekeeper, intermediary, ISP, payment intermediary
Abstract: This paper examines legal and policy issues raised by changes in payment methods related to the rise of the Internet. The two major changes - the rise of P2P systems like PayPal, and the rise of Internet billing systems (EBPP) to replace the use of paper bills and checks - both involve new intermediaries that facilitate payments made by conventional payment systems. The paper first discusses how those systems work. It then discusses problems in the framework currently used to regulate those systems in the United States, which has not been updated to protect consumers from the special problems those systems raise. Finally, the paper considers problems with the potential shift of payments services from the heavily regulated banking industry to new and unregulated Internet-related startups. The paper considers a variety of strategies for producing a level field of competition between banks and the new entities and at the same time providing adequate protection for the consumers that use the systems in question.
electronic payments, P2P, EBPP, EFTA, TILA, gatekeepers
Abstract: This paper analyzes the effects of credit card use on broader economic indicators, specifically consumer credit, and consumer bankruptcy filings. Using aggregate nation-level data from Australia, Canada, Japan, the United Kingdom, and the United States, I find that credit card spending, lagged by 1-2 years, has a strong positive effect on consumer credit. Finally, I find a strong relation between credit card debt, lagged by 1-2 years, and bankruptcy, and a weaker relation between consumer credit, lagged by 1-2 years, and bankruptcy. The relations are robust across a variety of different lags and models that account for problems of multicollinearity and auto-correlation in the time series and include variables to control for the effects of economic cycles on bankruptcy and dummy variables to isolate nation-specific effects
credit cards, consumer credit, bankrutpcy
Abstract: A major shift toward open source software is underway as companies are more critically evaluating the cost effectiveness of their IT investments, seeing the benefits of collaborative development, and looking for ways to avoid vendor lock-in. At the same time, academics and industry visionaries are criticizing the use of a traditional appropriation mechanism for innovation - the patent - by bemoaning the decisions of U.S. and foreign governments to permit software patents, the rising numbers of patents on software-related innovations (the so-called arms race build-up), and the cost and frequency of patent litigation in the software industry. The critics generally have applauded the shift towards open source, albeit for somewhat varying reasons. This paper responds to those trends by analyzing the role of property rights in the open source development model, with a particular focus on the effectiveness of the appropriation mechanisms that the open source model uses in lieu of intellectual property rights. I make two main points. First, I argue that open source's commercial success is intertwined with its incorporation into traditional commercial value chains. What that means is that open source cannot continue to grow in commercial importance without the property rights that are necessary for profit at other points of the value chain. Second, I argue that despite open source's distributed development process, open source in the real world is likely to support an increasing concentration in the software industry. The reason is that the proprietary firms best situated to exploit commercial interactions with open source will be large firms, particularly large service firms. Smaller firms will be less successful as services firms, and far less successful at exploiting the value-chain interactions that have driven commercial open source.
software, open source, patents, IP
Abstract: This is a substantially revised and focused version of Payments Policy in the Information Age (abstract id 214632). This essay in its new form explores how we should design a coherent payments policy, focusing on the incoherence of existing policy related to credit and debit cards. The central point of the essay is that previous analysis has failed to recognize the importance of the underlying transactions in which payments are made to issues ordinarily treated in the legal rules that regulate payment systems. Generally, I argue that issues of payments policy need to be separated into two categories: those for which determination of the appropriate rule is heavily influenced by the technology of the payments system; and those for which determination of the appropriate rule depends for the most part on the nature of the underlying transaction. Among other things, that suggests that issues of finality should be driven more by transactional considerations, while issues about unauthorized transactions should be driven more by the nature of the technology. To illustrate that framework in application, I turn in the remainder of the essay to the most rapidly growing payment systems in our economy, credit and debit cards. I generally argue that concerns about an imbalance of leverage between merchants and consumers justify broader inroads on finality of payment than existing law contemplates. At the same time, the essay emphasizes the importance of permitting different types of payments so that merchants and consumers can choose from a menu of payment options.
payment systems, credit cards, debit cards
Abstract: This paper analyzes the relation between the patenting behavior of startup firms and the progress of those firms through the venture capital cycle. Linking data relating to venture capital financing of software startup firms with data concerning the patents obtained by those firms, we find significant and robust positive correlations between patenting and several variables measuring the firm's performance (including number of rounds, total investment, exit status, receipt of late stage financing, and longevity). The data also show that (1) only about one in four venture-backed software firms acquired even one patent during the period of the study; (2) patenting practices very considerably among the sub-sectors of the software industry; and (3) the relationship between patent metrics and firm performance depends less on the size of the patent portfolio than on the firm's receipt of at least one patent.
patents, venture capital, software, IP
Abstract: This paper relies on data from countries around the world to present a comprehensive analysis of policy issues related to credit cards. The first part discusses the rise of credit cards and debit cards and how their uses differ from country to country. It closes with a framework for explaining why cards are more and less successful in different countries, focusing in large part on the ready availability of detailed consumer credit information. The second part considers the relation between credit card use and bankruptcy. Relying on a time series of data from the United States, Canada, Great Britain and Australia, the analysis shows that credit-card debt correlates positively with consumer bankruptcy, even when consumer credit is held constant. Thus, if a country's total consumer debt burden remains constant, but a portion of the debt shifts to credit cards, the data suggests that consumer bankruptcies will rise in the future. {The relationship is strongest with a one-year time lag.} The third part considers various policies related to credit card use. It criticizes the interchange restrictions being considered in Australia, the EU, and the UK, and recommends several changes to American law. The most important would be restrictions on marketing to minors and college students, restrictions on affinity programs that are tied to a consumer's decision not to repay their charges monthly, and requirements of enhanced disclosures at the point of sale.
credit cards, debit cards, consumer bankruptcy, TILA, EFTA
Abstract: Although software is one of the most important assets many businesses hold, almost nothing has been written about the dynamics of software financing. Under a conventional view of secured financing, the difficulties of liquidating software would limit its value as collateral for secured loans. But the actual transactions belie that view, because lenders advance billions of dollars in asset-based software loans each year. Part I of the article describes the legal and practical difficulties that make it so impractical for a lender to liquidate software-related collateral: the uncertainty about where to file; the requirement that the borrower deposit the source code with the Copyright Office; the impossibility of perfecting an interest in software-to-be-developed; and the need to obtain the licensor's consent to the liquidation. The factors described in Part I of the article suggest that software-based lending should be at best risky and unusual. Parts II and III show, however, that businesses have developed transactional structures that overcome those difficulties. First, Part II describes the use of debt to facilitate the development of new software products. The lenders in those transactions ordinarily overcome the difficulties of obtaining value from the underlying assets of their borrowers by developing a highly symbiotic relation with a venture capitalist. Part III then describes the use of debt to facilitate the acquisition of large-dollar commercial software products. In that context, parties overcome the lack of liquidation value by use of the leverage that comes from a right to terminate the purchaser's use of the software. Because that remedy is independent of the classic secured creditor's remedies of repossession and foreclosure, it poses significant difficulties for the legal system. In one context, proposed revisions to the Uniform Commercial Code purporting to aid software financiers actually have harmed those lenders by calling into question the permissibility of that remedy. More generally, the treatment of the software lender in bankruptcy is complicated by the traditional division of creditors' claims into "secured" and "unsecured" categories, that is used to bestow favorable treatment on the claims classified as "secured." Because the right to terminate use falls outside traditional notions of secured lending, the Bankruptcy Code provides little protection for the lender that relies on that remedy. But that treatment is perverse because the unsecured lender has put itself in a position to be well protected under the state-law system, better protected than it would have been if it had relied on a conventional secured claim. The end result is a system in which the law encourages software financiers to engage in "sham" secured transactions -- those that purport to take a security interest, but include no right of liquidation. The article recommends resolution of that situation by affording recognition in bankruptcy to the termination right of the software-acquisition lender.
Abstract: Those that backed the 2005 bankruptcy reform law argued that it would protect creditors from consumer abuse and lack of financial responsibility. The substantial increase in the number of bankruptcies over the last decade combined with the perception of system-wide abuse apparently convinced legislators from both political parties that the backers had a point. Thus, Congress enacted amendments to the Bankruptcy Code that - if effective - would fundamentally change the core policies underlying the consumer bankruptcy system in this country. The rhetoric surrounding the reform debates pressed the idea that if borrowers had to repay more of their debts, creditors would achieve savings that - through pressures of competition - would be passed on to consumers in the form of lower interest rates and improved access to credit. This essay addresses some of the problems with this justification and considers what else creditors (and particularly credit card issuers) could have expected to achieve with the new law. I argue that the new law will benefit issuers substantially, though not for reasons commonly discussed in the negotiation and drafting of the statute. Means testing alone will not return enough in increased bankruptcy payouts to justify the lobbying expenditures and campaign contributions that led to the statute's enactment. Rather, the most important effect will be to facilitate the card lending business model, by slowing the time of inevitable filings by the deeply distressed and allowing issuers to earn greater revenues from those individuals. In a nutshell, the new law does little for creditors once they reach the courthouse. Its most important effect will be to enable issuers to profit from debt servicing revenues paid by distressed borrowers who are not yet in bankruptcy. For issuers that depend on debt revenues, the benefits of the law could be dramatic.
Bankruptcy, credit card, debt, credit, reform
Abstract: The growth of payday lending markets during the last 15 years, both in the United States and abroad, has been the focus of substantial regulatory attention, producing a dizzying array of initiatives by federal and state policymakers. Those initiatives have conflicting purposes - some seek to remove barriers to entry and others seek to impose limits on the business model and those who participate in it. As is often the case in banking markets, the resulting patchwork of federal and state laws poses a problem when one state is able to dictate the practices of a national industry. For most of this industry's life, just that has happened - states with the least restrictive laws effectively displaced states with more restrictive laws. Recently, however, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation significantly changed their policies on payday lending. Now, for the first time, States can effectively police payday lenders in their borders. Yet as we enter this new stage in which States will be able to regulate payday lending effectively, there has been little clear analysis of how they should do so. This paper responds to that opportunity by providing a detailed explanation of the business models and regulatory regimes that exist today, together with a framework of options designed to implement various perspectives regulators might adopt. We emphasize three main points. The first is the unusual nature of payday lending, with very high interest rates accruing against necessarily limited debt amounts. Unlike credit card lending, the payday loan amount does not increase over time, but the biweekly interest obligation can lead to a semi-permanent cash annuity for the lender. In our view, those features present challenging issues for regulators. Second, we underscore the limitations of existing legal regimes, which often leave loopholes that permit lenders to avoid the statutory framework; this is a particularly serious problem for the majority of States that have tried to limit rollover lending. Third, addressing the majority of jurisdictions that have not banned the product, we advocate a reversal of the current hostility to market activity by large institutions. If the market is to exist, we believe it is better for it to be populated by highly visible national providers than by smaller fly-by-night providers.
payday lending, bank regulation, consumer finance, cognitive failure
Abstract: This article examines the institutions that private parties have developed to resolve information asymmetries in financing transactions. It analyzes all of those institutions as variations on the hostage/bond transaction commonly described in the context of relational contracting. The article proceeds in three steps. The first part provides a simple model of the bonding process that I use to describe the institutions discussed later in the article. That part emphasizes how a one-sided punitive hostage or bond arrangement provides a useful solution by enhancing the cost of a breach yet minimizing the incentive to opportunism by the holder of the bond. It also describes a variety of transactional difficulties that limit the circumstances in which the bond arrangement can be effective. The second part uses that model to describe how and when that arrangement works for transactions that involve collateral, relational contracting, and reputational bonds. It concludes that many transactions that at first glance appear to involve that arrangement (such as secured commercial lending transactions) in fact do not rely on the incentives from that arrangement. The third part extends the model to situations in which the borrower and the lender rely on a third party to verify information, either through use of a financial commitment (in the case of a guaranty or surety arrangement) or through some direct assertion of the information.
Abstract: This paper investigates the effect of advances in information technology on the private institutions that businesses use to resolve information asymmetries in financing transactions. It discusses four separate effects. First, in some cases information technology will permit direct verification of the information, obviating the problem entirely; the paper discusses the example of the substitution of the debit card for the check, which provides an immediate payment that obviates the need for the merchant to consider whether payment will be forthcoming when the check is presented to the bank on which it is drawn. Second, the paper discusses how advances in information technology improve the functioning of reputational verification systems, with a special emphasis on the dis-intermediation of securities issuance. Third, the paper discusses the rise of intermediation by pooling in the area of securitization. The paper closes by discussing the information merchant, which can sell information directly to those who need it for their transactions.
Abstract: We analyze the relation between patents and the different business models available to firms in the software industry. The paper builds on Cusumano's work defining the differences among firms that sell products, those that provide services, and the hybrid firms that fall between those polar categories. Combining data from five years of Software Magazine's Software 500 with data about the patenting practices of those software firms, we analyze the relation between the share of revenues derived from product sales and the firm's patenting practices. Accounting for size, R&D intensity, and sector-specific effects, the paper finds a robust positive correlation between product-based business models and patenting rates. We also present in this draft preliminary results suggesting that there is no significant relation between patenting practices and the extent to which the firm's revenues are derived from software products and services, as opposed to hardware or other lines of business.
patent, business, software, IP, model
Abstract: Scholars for decades have noted the possibility that standard-form contracts disadvantage consumers. For many years, that literature focused on the idea that sellers with market power draft contracts that are disadvantageous to consumers. Law and economics scholars, however, have been skeptical about that hypothesis, pointing out that a strategy of inefficient terms rarely would be the optimal technique for exploiting market power. In recent years, however, the debate has shifted as new product distribution channels have changed the technology of contracting. Now, even firms without market power can exploit the cognitive failures of their customers through "shrouding" of terms and similar techniques. That concern has become more prominent with the rise of Internet retailing, where electronic standard-form contracts are used extensively, often undermining the notion of assent on which the contract paradigm traditionally depends. Scholars have worried that Internet retailers obscure one-sided terms so that customers will continue to shop at their sites, and do so more effectively than their brick-and-mortar counterparts. This, among other concerns, has led many to argue for a new contracting regime that deals with electronic contracting. Indeed, because software is often distributed online, this is a major topic in the ALI's current project on Principles of the Law of Software Contracts.
internet, law, retail, contract
Abstract: We analyze the characteristics of the patents held by firms in the software industry. Unlike prior researchers, we rely on examination of the individual patents to determine which patents involve software inventions. This method of identifying the relevant patents is more laborious than the methods that previous scholars have used, but it produces a dataset from which we can learn more about the role of patents in the software industry. In general, we find that the patents computer technology firms obtain on software inventions have more prior art references, claims, and forward citations than the patents the same firms obtain on non-software inventions. We also find that the patents that software firms obtain on software inventions also have more prior art references, claims, and forward citations than the software patents obtained by the firms that derive revenues from other product lines. Finally, we conclude that the patents of the largest firms are no better (or worse) than the patents of the smallest firms, belying the idea that large firms are plagued by challenges based on the worthless patents of their smaller competitors. The paper closes with a brief discussion of the implications of our empirical analysis. The findings undermine the strongest criticisms about the low quality of software patents. It is simply not accurate to say that software patents as a class have remarkably low numbers of prior art references and forward citations. Thus, they cut against technology-based patent reforms designed to make it more difficult to obtain software patents. On the other hand, the evidence that small firms are no less capable than large firms at producing quality patents vitiates concerns that higher hurdles at the early stage of the patenting process would disadvantage smaller inventors in particular.
software, patents
Abstract: Software patents have been controversial since the days when "software" referred to the crude programs that came free with an IBM mainframe. Different perspectives have been presented in judicial, legislative, and administrative fora over the years, and the press has paid as much attention to this issue as it has to any other intellectual property topic during this time. Meanwhile, a software industry developed and has grown to a remarkable size, whether measured by revenues or profitability, number of firms or employees, or research expenditures. The scope of software innovation has become even broader, as an increasing number of devices incorporate information technology, requiring modern manufacturing firms outside the software industry to employ developers and programmers to ensure that increasingly diverse functions are performed more efficiently. Although inventors have consistently asserted their need for patents in order to compete with industry incumbents, patent protection has not been easily or consistently available for much of this period. Rather, the legal system has responded gradually to the burgeoning software industry by broadening the scope and strength of protection for software-related inventions in fits and starts. The explosive growth of the industry is largely attributable to demand generated by the efficiency of software solutions; the expansion of the venture capital industry over the same period largely explains the lack of industry concentration. The "garage" mentality can be explained by the fact that even some of the largest industry incumbents began with one or two (largely unfunded) inventors. Also, there is every reason to believe that increased patent protection has contributed to the ability of independent inventors and smaller firms to compete. Moreover, the ability to obtain patents on software always has been important to some of the industry incumbents, while others have exhibited little need for patents and, displayed in some cases, strenuous opposition to the patentability of software. The incumbents are a diverse group. Some produce only software; others have substantial hardware product lines. Some sell to other technology firms and others sell applications to end users in a broad range of markets. And some sell prepackaged software products, while others focus on services - custom programming, installation, or maintenance. Regardless of the sector in which they participate, the incumbents spend massive amounts on research and development (R&D) - about 14% of their annual revenues, more than $60,000 per employee. However, there are important patterns in patenting practices that raw data on R&D investments cannot explain.
Abstract: This is a paper for a conference at Cardozo Law School on the relation between securitization and secured credit. Concerns about securitization have been focused by decisions of various States to take the lead in attempting to decide how those issues will be resolved in bankruptcy proceedings. In this paper I step back from that debate to ask a more fundamental question: who is to decide the appropriate policy response to those issues? On the one hand, Congress could decide those questions in the exercise of its exclusive constitutional power to enact bankruptcy laws. Or, if it chose to do so, in the exercise of its authority over interstate commerce. Conversely, the states could resolve those questions in the exercise of their traditional control over basic issues of commercial law, reflected most prominently in the Uniform Commercial Code. Securitization raises difficult policy questions in part because it falls at the boundary between those two spheres: the effect and legitimacy of those transactions is plainly is an important question of commercial law, but much of what is most important involves specific questions about how the transactions are treated in bankruptcy. This paper is distinct from the body of existing literature on the topic because I am focusing not on the commercial-law questions common to discussions of the topic - Are the securitization transactions efficient? Do they inappropriately undermine the stability of originators? - but instead on federalism questions: as a matter of allocation of power, when does the supervening power of federal law preempt state efforts to address those questions? My analysis proceeds in three steps. First, I describe the basic system that successfully delineated responsibility between Congress and the state legislatures until recent years (perhaps about 1990), and a number of systemic factors that have caused the old system to break down. Second, I discuss examples of potentially problematic legislation - not only legislation related to securitization, but other pieces of state legislation that have their primary effects in the bankruptcy of the affected parties. Finally, I use those examples to illustrate when those statutes should - and should not - be held preempted by Congress's authority under the Bankruptcy Code.
securitization, bankruptcy, federalism, preemption
Abstract: Although academics spend a great deal of time analyzing the fine details of the rules that govern negotiable instruments, they have spent little or no time attempting to ascertain whether those rules play a significant role in the modern economy. This article takes up that question from an empirical perspective, presenting evidence from more than a dozen interviews with professionals in a variety of different financial markets, a survey of actual documents used in various financial transactions, site visits to a number of financial institutions, and a survey of published judicial decisions in the checking area. Relying on that evidence, the article shows how and why negotiability has faded from significance. Part I shows how the benefits that negotiability offers were designed to aid the simple transactions that were common in preindustrial economies. To show just how rarely negotiability appears in modern commerce, Part II examines current practices in a variety of contexts in which negotiability is not a significant factor: credit cards, letters of credit, consumer-credit notes and home-mortgage notes, private commercial obligations, bonds, and commercial paper. Part III discusses the last significant area in which negotiable instruments still appear, the checking system. Even there, though, the exigencies of modern commerce have rendered irrelevant to actual practices all of the fundamental concepts of negotiability: reliance on the document to represent rights in the instrument, use of signatures to transfer and verify ownership, and even holder-in-due-course status. Finally, Part IV closes with some brief comments about the continuing convergence of payment systems in response to technological pressure.
Abstract: Credit card transactions might be at once the most perilous and least regulated consumer credit transaction. The relative lack of regulation is surprising considering the way consumers use cards in payment and borrowing markets. Card agreements have many of the traditional shortcomings associated with standardized financial contracts. They are lengthy and detailed. They conceal terms of economic import. They are complex. They use technical language requiring an advanced understanding of legal and financial concepts. Moreover, the agreements define a transactional structure that plays into several common behavioral biases, which unite to desensitize consumers to the risks of borrowing. Card agreements also raise distinct issues. The trifurcated structure of credit card transactions (with separate points of agreement, purchase and borrowing) deemphasizes the significance of the contract itself; the important decisions are made when the consumer decides to spend and then to borrow. The small amounts involved in the individual spending and borrowing decisions render them trivial on an individual basis. Yet the triviality of the individual transactions obscures the significance of aggregate card borrowing. Time is also a factor. Because the transactions occur over an extended period, issuers generally retain the right to change the terms on which they extend credit. They do so with some regularity. Further, the changes typically apply to existing balances, which complicates the risk assessment that the consumer makes at the point of sale. A related issue is notice. Because issuers typically provide little or no advance notice when making changes, consumers often are not able to find other credit arrangements in time to avoid retroactive adjustment of the contract terms. A final point that distinguishes credit cards from other consumer credit transactions is that many consumers have not one, but several, different accounts with terms that differ in important respects. Although credit cards are a global economic phenomenon, involving many market participants (large numbers of issuers and merchants and several leading networks) and a heterogeneous group of users, and raising a number of different policy issues in distinct payment and borrowing markets, this paper considers a narrow topic: the viability of direct regulation of the cardholder/issuer relationship. After discussing several forms of regulation suggested in the existing literature, I discuss the merits of prohibiting "unpriceable" terms and standardizing contract forms. At a minimum, I argue, we should prohibit the imposition of terms that purport to apply to existing debts - imposing risks on customers that they cannot plausibly account for when they use the card. More broadly, I think the best approach - paralleling the treatment of other major consumer financial transactions like home mortgages and insurance policies - would be to promulgate standardized terms. As I discuss, the standardized terms could come either from regulators or from industry intermediaries. In either case, those agreements could force competition to a limited number of product features that consumers reasonably can evaluate.
credit cards, boilerplate, behavioral economics
Abstract: This chapter uses data from the Federal Reserve Board's Survey of Consumer Finances for 2004 (the "SCF") to examine the penetration of credit cards into LMI markets. The chapter has two purposes. First, I discuss the rise of the modern credit market, emphasizing the segmentation of product lines based on behavioral and financial characteristics of customer groups. Among other things, that trend involves the use of products aimed at LMI households that differ significantly from those aimed at middle-class households. Second, I describe the extent to which LMI households borrow on credit cards, the types of LMI households that borrow, and how they differ from the more affluent households that borrow. Despite lower incomes, credit card use is almost as common among LMI households as it is among more affluent households. Indeed, measured as a share of income, the credit card balances that LMI cardholders carry are substantially higher than those of more affluent households. To check the robustness of those results, the chapter closes with the results of a multivariate regression analysis of the characteristics of LMI households with credit card debt. Generally, those results suggest that the demographic characteristics of LMI households that have credit card debt are different in material ways from the characteristics of those with credit card debt in the overall population. The models that I summarize here suggest that age, race, and education are important predictors of credit card use in the population at large. At least in these models, however, age and race become insignificant and education is only marginally important in predicting credit card use in LMI households. In LMI households, by contrast, the most significant predictors of credit card use are employment status, the use of other financial products (checking accounts, mortgage loans, and car loans), and marital status.
Abstract: This article explores the relationship between consumer credit markets and bankruptcy policy. In general, I argue that the causative relationships running between borrowing and bankruptcy compel a new strategy for policing the conduct of lenders and borrowers in modern consumer credit markets. The strategy must be sensitive to the role of the credit card in lending markets and must recognize that both issuers and cardholders are well placed to respond to the increased levels of spending and indebtedness. In the latter parts of the article, I recommend mandatory minimum payment requirements, a tax on distressed credit card debt, and the subordination of payments to credit card lenders in bankruptcy. I also argue that many aspects of the American bankruptcy system, as recently reformed, are overly protective of credit card issuers.
Consumer credit, credit cards, bankruptcy, usury
Abstract: This is a reply to Omri Ben-Shahar's Contracts with Consent, forthcoming in the Pennsylvania Law Review, and will be published along with his essay in that journal. The reply makes two main points. First, it argues that Omri's no-retraction liability regime will impose substantial costs, largely because of the frequency with which parties will have non-opportunistic reasons for retracting contract proposals that their negotiating partners have not yet accepted. Second, it argues that these costs will be substantial even though Ben-Shahar presents his proposal as a default rule. First, his rule vitiates the information-forcing benefits of the current default rule. Second, the stickiness of any default rule means that inefficiencies in the rule will not be solved by the ability of parties to opt out of the rule. Ben-Shahar's rule is likely to be especially sticky, because it applies by definition in a context in which the parties will NOT previously have signed a formal contract.
contracts, reliance damages, expectation damages, default rules
Abstract: This article provides an empirical and theoretical study of the processes for the liquidation of secured debt. The empirical portion of the study includes an empirical base of 74 profiles of distressed secured loans randomly selected from the portfolios of three lenders (one finance company, one bank, and one insurance company). Those profiles include information on such topics as how the lenders decide which loans to terminate, what happens to the debtors after the lender decides to terminate the relationships, how successful the lenders are in obtaining repayment, and how much the process of termination costs. The theoretical portion of the study builds on the base of empirical evidence in two ways. The first part of the theoretical discussion presents a model of the economics of distressed debt. I argue that debtors are surprisingly capable of protecting themselves even in the face of demands for payment from their lenders, relying on the substantial incidence in my profiles of transactions where the debtors either refinanced their loans or paid them off with cash flow generated from continued operations or sale of the underlying collateral. As a related point, I argue that extremely poor results lenders face in cases where they foreclose rebut the concerns of some academics about the ability of lenders to use foreclosure to capture valuable assets from their borrowers. The second part of the theoretical discussion addresses broader questions about the connection between the market for distressed debt and the larger market for the initial issuance of debt. First, based on the very low frequency of liquidation and the poor results that lenders obtain on liquidation, I argue that the principal reasons that lenders take collateral are the strategic advantages it gives them; the enhancement of their power to liquidate collateral by force is of so little value that it cannot plausibly be viewed as a general justification for those transactions. Accordingly, legal reforms of the secured-credit system should focus more on the serious policy issues raised by those strategic advantages than on perceived difficulties in obtaining a reliable right to liquidate. I close by addressing the long-standing concern that rules hindering creditors' collection efforts will affect the willingness of lenders to issue new loans. My evidence of the low frequency of business failure and bankruptcy strongly suggests that the concern is for the most part unfounded.
Abstract: This paper compares a dataset of failed venture-backed firms to information about the firm's liquidation choices. The first finding is that firms in California are much less likely to use the bankruptcy process than firms in other states, largely because of their ability to use a cheaper and less formal assignment for the benefit of creditors procedure. The paper explores a number of reasons why that procedure succeeds in California more than it does elsewhere, including differences in statutory support for the procedure, the sophistication of market participants in California, the close-knit venture communities in California, and unusual rules of 9th circuit bankruptcy law. The second finding comes from the data about the firms that did file for bankruptcy. Generally, those firms were much larger, with much greater amounts and varieties of debt than previous scholars had predicted. The paper uses that data to discuss the role that bankruptcy can play in the liquidation of high-tech firms.
bankruptcy, software, venture capital
Abstract: This chapter tells the story behind BFP v. Resolution Trust Corporation. I see BFP as a case that pitted relatively plain statutory language supporting the debtor-in-possession against policy interests supporting a secured creditor. I argue that an important explanation for the Supreme Court's decision to favor policy over the language of the statute was its perception of a need to protect the availability of non-bankruptcy remedies for secured creditors. Accordingly, I situate my discussion of BFP in the context of the role that the federal government has played in the Supreme Court's cases interpreting the Bankruptcy Code. In general, I contend, the Supreme Court's decisions evince a general skepticism about broad application of the Bankruptcy Code, which often has led to surprisingly narrow interpretations of relatively clear language. That reading challenges the common understanding of bankruptcy law as a domain of the Court's plain-language interpretative practice.
bankruptcy, debt, supreme court
Abstract: This paper situates Wal-Mart's failed application to form a banking subsidiary in the context of payments policy. Generally, I argue that permitting Wal-Mart to have a bank would have a salutary effect on the relatively uncompetitive market for payment networks. The dominant position of Visa and MasterCard, in which payments are priced above cost to subsidize credit, inevitably will give way to a world in which payment services are priced at cost, or even below cost as a loss-leader to attract customers to other goods and services. Entry into this market by Wal-Mart would be likely to spur more robust competition and thus lower pricing more rapidly.
Abstract: This paper is an empirical and analytical investigation of priority in construction lending. It rests on a substantial set of interviews with construction lenders and borrowers. Generally, it argues that construction lenders are better placed than mechanic's lien claimants to implement procedures that limit the risk of borrower defalcation. Accordingly, it recommends a reversal of the ordinary rule of priority, which permits construction lenders to have priority over mechanic's lien claimants. A reversal of the rule of priority will more effectively police borrower defalcation.
lending, lien
Abstract: Increased rates of consumer bankruptcy filings are a policy concern around the world. It is not easy, however, to explain the variations in per capita filing rates from country to country. Some of the variation is attributable to different levels of indebtedness. Some is attributable to different cultural attitudes about financial failure. And some is attributable to the accessibility of the legal system as a remedy for irremediable financial distress. This paper analyzes the differences in nation-level, per capita filing rates. I start with a model that uses economic variables to explain nation-level variations in filing rates. The economic and statistical significance of the coefficients on country dummy variables in that model suggests that noneconomic variables also play an important role in explaining differences in filing rates. Two findings are salient. First, the bulk of the uniquely high filing rate in the United States is attributable to economic conditions, not cultural attitudes or the legal system. Second, after controlling for economic conditions, Canada's filing rate is by far the highest of any of the countries for which adequate data is available. The paper then undertakes to explain those findings. It considers both why Canada's propensity to file is so much higher than that of the U.S., and why Australia's is so much lower. Generally, back-end issues related to the timing of a discharge and the payments required to obtain it are relatively unimportant. Back-end issues matter primarily to the relatively small sector of bankruptcy filers with significant income or assets. For the great mass of potential filers (who have little or no income or assets), the most important issues are front-end barriers to filing, whether they come from procedural obstacles or from cultural attitudes about financial distress (as reflected in civil disabilities imposed on bankrupts).
bankruptcy, consumer finance, and payment systems
Abstract: This paper examines how the risks of debt, financial distress, and bankruptcy shift over the life course. The paper compares data from the 2007 Survey of Consumer Finances and the 2007 Consumer Bankruptcy Project to illustrate the ways in which bankrupt households differ from typical households. The paper suggests that there are age differentials in the distribution of unplanned events and in the ability of households to use credit markets to limit the adverse effects of those events; as a result, the typical patterns of bankruptcy filers differ by age. The paper relates those effects to a substantial increase in recent decades in the incidence of financial distress and bankruptcy among the elderly.
financial distress, bankruptcy, life course, consumer credit, SCF, CBP
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