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Abstract:
We demonstrate how a golden parachute can be used to improve the target shareholders' net return by partially shifting the managerial compensation burden to the buyer through a higher acquisition price. Consistent with the empirical observations, we show that (1) the golden parachute will be contingent on a change-of-control rather than solely on the manager's layoff, (2) the golden parachute will be promised early, for example, at the time of the manager's employment, not just in the face of a takeover or a merger, (3) the shareholders would want to extend its coverage to other employees, and (4) the size of the parachute can be much larger than the manager's annual compensation. We also examine the effect of a golden parachute on the managerial incentive scheme.

Abstract:
We demonstrate how a golden parachute can be used to improve the target shareholders' net return by partially shifting the managerial compensation burden to the buyer through a higher acquisition price. Consistent with the empirical observations, we show that 1) golden parachute will be contingent on a change-of-control rather than solely on the manager's layoff, 2) golden parachute will be promised early, e.g., at the time of the manager's employment, not just in the face of a takeover or a merger, 3) the shareholders would want to extend its coverage to other employees, and 4) the size of the parachute would be much larger than the manager's annual compensation.

Abstract:
When a seller encumbers a property with a right of first refusal, whenever a third party offers to purchase the property, the right-holder can acquire the property by simply matching the third party's offer. We model the right as a modified auction where the right-holder gets to observe the third party's bid before making his own. We show that, compared to the standard auctions, the right increases the joint profit of the seller and the right-holder by reducing the third party's profit. This result is independent of whether the third party is aware of the right's existence and whether the right creates a welfare loss.

Abstract:
A contingent fee contract improves a plaintiff's bargaining position against a defendant by providing incentive to the plaintiff's lawyer. Setting the lawyer's share of judgment high will induce more effort from the lawyer while keeping the lawyer's settlement share low will reduce the legal fees and the lawyer's rent. When the plaintiff negotiates against a tough-bargaining defendant, however, legal fee saving accrues mostly to the defendant through a lower settlement offer. To maximize her return from settlement, the plaintiff would want to delegate control to the lawyer and guarantee him a large rent. She would want to delegate especially when the lawyer is more expensive and the size of the claim is small, as in individual tort cases.

Litigation, contingent fee, delegation

Abstract:
A contingent fee contract improves a plaintiff's bargaining position against a defendant by providing incentive to the plaintiff's lawyer. Setting the lawyer's share of judgment high will induce more effort from the lawyer while keeping the lawyer's settlement share low will reduce the legal fees and the lawyer's rent. When the plaintiff negotiates against a tough-bargaining defendant, however, legal fee saving accrues mostly to the defendant through a lower settlement offer. To maximize her return from settlement, the plaintiff would want to delegate control to the lawyer, even though this leaves the lawyer a sizable rent. Delegation is most effective 1) when the lawyer is most expensive and 2) the size of the case is small, as in individual tort cases.

litigation, contingent fee, delegation

Abstract:
The doctrine of successor liability transfers tort liability arising from the seller's past conduct from the seller to the buyer. If the buyer has as much information about the liability as the seller, all beneficial acquisitions take place and the seller takes the efficient level of precaution. However, if the seller has more information about the liability than the buyer, not all beneficial acquisitions are consummated and the seller takes a suboptimal level of precaution. I argue that, in the presence of information asymmetry, the courts should increase the damages against the (potential) seller to provide better incentives to take precaution while decreasing the damages against the buyer to encourage more beneficial asset sales.

K13, K22, K32

Abstract:
The doctrine of successor liability transfers tort liability arising from the seller's past conduct from the seller to the buyer. If the buyer has as much information about the liability as the seller, all beneficial acquisitions take place and the seller takes the efficient level of precaution. However, if the seller has more information about the liability than the buyer, not all beneficial acquisitions are consummated and the seller takes a suboptimal level of precaution. I argue that, in the presence of information asymmetry, the courts should increase the damages against the (potential) seller to provide better incentives to take precaution while decreasing the damages against the buyer to encourage more beneficial asset sales.

Abstract:
Professors Polinsky and Che advocate decoupling what plaintiffs recover from what defendants pay in damages, specifically arguing that lowering recovery and raising damages (by appropriate amounts) delivers the same level of primary activity deterrence with fewer filed suits. Professors Kahan and Tuckman extend Polinsky and Che's analysis to account for the effect of parties' litigation stakes on the cost of each filed suit, provisionally concluding that Polinsky and Che's basic argument remains intact. This article reaches a different conclusion. We show that when the effect of litigation stakes on litigation effort is more fully taken into account, lowering recovery and raising damages may no longer improve social welfare. In addition, we characterize the kinds of suits in which the optimal level of recovery is no less than the optimal level of damages. Of rhetorical significance in the current policy debate, we find that such suits resemble the negative picture of modern litigation invoked by some advocates of reduced recovery. Our basic findings are robust to the possibility of out-of-court settlement, plaintiffs' employment of contingent fee lawyers, and alternative fee-shifting rules.

Abstract:
Professors Polinsky and Che advocate decoupling what plaintiffs recover from what defendants pay in damages, specifically arguing that lowering recovery and raising damages (by appropriate amounts) delivers the same level of primary activity deterrence with fewer filed suits. Professors Kahan and Tuckman extend Polinsky and Che's analysis to account for the effect of parties' litigation stakes on the cost of each filed suit, provisionally concluding that Polinsky and Che's basic argument remains intact. This article reaches a different conclusion. We show that when the effect of litigation stakes on litigation effort is more fully taken into account, lowering recovery and raising damages may no longer improve social welfare. In addition, we characterize the kinds of suits in which the optimal level of recovery is no less than the optimal level of damages. Of rhetorical significance in the current policy debate, we find that such suits resemble the negative picture of modern litigation invoked by some advocates of reduced recovery. Our basic findings are robust to the possibility of out-of-court settlement, plaintiffs' employment of contingent fee lawyers, and alternative fee-shifting rules.

Abstract:
It is well-established that non-profit hospitals employ performance bonuses with much lower frequency than for-profit hospitals. Weisbrod (1999, 2003a, 2003b) suggest that this implies that principals of non-profit and for-profit firms have different objectives or purposes. Brickley and Van Horn (2002) dispute the different-objectives hypothesis. They present evidence that the salaries and turnover of executives at non-profit hospitals reward financial performance but not altruistic activities. Employing a unique data set of executive compensation at 2,700 nursing homes in 2001 and 2002, this paper improves on Brickley and Van Horn's analysis in three important ways. First, we provide an explanation for how non-profit firms and for-profit firms may both seek to reward financial performance but write different executive compensation contracts. This explanation relies upon tax penalties on the use of financial rewards for executives by non-profit firms. Second, we introduce direct comparisons of wages at non-profit and for-profit facilities as well as superior controls for quality of patient care and the risk profile of patients. Third, we consider the implications of observed patterns in executive compensation for alternative theories of non-profit behavior, such as quality/quantity maximization. We conclude that executive compensation at non-profit firms supports that the hypothesis that principals at non-profit firms either care about profits just like principals at for-profit firms (the strong version of the for-profit-in-disguise model) or behave as if they do (the weak version).

non-profit, nursing home, tax, executive compensation

Abstract:
Contract theory typically holds that verification costs are obstacles to complete contracting; yet, real world contracts often contain provisions that seem costly to verify. We show how a costly signal can play an important role in contracts. Verification (or litigation) costs operate as a screen on the promisee's incentive to sue and as an effective sanction against the breaching promisor. So long as the court's judgment is correlated with the promisor's behavior, therefore, the parties can design a set of prices (including damages) so as to provide additional incentive to the promisor through an off-the-equilibrium, credible litigation threat. We show that the parties may prefer to adopt a costly signal over a costless signal. Rather than focusing solely on either the problems of adjudication or those of contracting (without sufficient regard to how the disputes will be resolved in the future), we have attempted to take a more comprehensive approach by looking at the design of contracts in anticipation of the path of the adjudication process.

Incomplete Contracts, Costly Verification

Abstract:
Under the doctrine of vicarious liability, a deep-pocket principal is often held responsible for a third-party harm caused by a judgment-proof agent's negligence. We analyze the incentive contract used by the principal to control the agent's behavior when a court can make an error in determining the agent's negligence. We show that (1) reducing the error of declaring the agent not negligent even when he was (pro-defendant or type II error) is better than reducing the error of declaring the agent negligent even when he was not (pro-plaintiff or type I error) and (2) allowing the principal to penalize the agent even when the court declares the agent not negligent improves welfare. The latter supports the argument that causing an accident (or a reliable allegation of misconduct) should be sufficient to justify a just cause termination of an employee.

Abstract:
An important difference between intra-firm and inter-firm transactions is that the former takes place under the governance of a "headquarters," which often remains aloof from the transaction yet retains ultimate authority over it. We show that when trading parties' relationship-specific investments directly affect the other's profit, the presence of such headquarters is necessary to achieve the (ex ante) efficient level of investment. Further, because internal trade is not always optimal, we show how a poorly informed headquarters can implement (ex post) optimal type of trade. We present a simple mechanism that enables the headquarters to extract the managers' information through deliberate creation of disagreement over trade. The model is consistent with the real world headquarters' using divisional disputes in choosing between internal and external trades, as witnessed by Eccles.

Abstract:
The unprecedented and unanticipated economic and financial shocks of the past couple of years have led parties to look for contractual escapes from deals. Some parties exercise options embedded in their contracts by paying liquidated damages or cancellation fees. Others invoke excuse provisions such as force majeure, material adverse change or market-out clauses, to terminate at no cost. Under either set of circumstances, disputes arise, are litigated and typically settled either by a termination of the deals or adjustments to their terms. The increased attention paid to these provisions has illuminated the vague language with which these options and excuses are framed, and their uncertain interpretation. One instance in which this has been noted is the common use of material adverse event or change (MAE/MAC) conditions in corporate acquisition contracts.

As the current crisis works its way through our economic system, attention will be shifted from the collapsed deals to the design of future transactions. The vague language of past agreements has fueled disputes and threatened costly and uncertain litigation. Should future parties, in corporate acquisition deals and other commercial contracts, inject greater precision in their agreements? There are many proponents of this advice. However, we lack a theoretical framework for setting out the costs and benefits of vague and precise provisions. In this paper, we provide such a framework in order to improve awareness of the strategic use of vagueness in contracting.

The conventional rules-standards analysis suggests that vague terms are justified when the expected larger litigation costs in enforcing standards are outweighed by the lower costs of drafting. In acquisition agreements, this would suggest that vague MAC clauses yield benefits only by reducing front-end drafting costs. Yet, some proxies for material adverse change, such as quantitative thresholds in stock price, revenues or accounting earnings, are easy to draft and can be verified at low cost. They are usually noisy proxies, however, and therefore are not perfect.

We demonstrate that litigation costs, when properly harnessed, can in fact improve contracting by operating as a screen on the seller's decision to sue. We review three possible goals of MAC clauses: (a) to provide efficient incentives for investment and precautions against future contingencies by the seller between the time of the agreement and closing; (b) to allow the seller to better signal its private information to the acquirer at the time of contracting; and (c) to enable the seller to better signal private information at the time of closing, in order to promote ex post efficiency in terminating or executing the acquisition. We show that, in achieving these goals, vague provisions may work better than precise and even less noisy proxies.

contract design, mergers and acquisitions, options, litigation

Abstract:
Defenders of the odious debt doctrine, which bars creditors from collecting sovereign debts that financed the personal consumption of former dictators, argue that this rule would benefit populations following dictatorships and discourage would-be dictators from staging coups in the first place. We show that optimism about the doctrine is based on unrealistic assumptions about the motives and practices of dictators. With more realistic assumptions, the odious debt doctrine could be beneficial or harmful, depending on circumstances. Defenders of the doctrine have not made the empirical case that the net benefits would be positive if the doctrine were incorporated into international law, and there is ample reason for skepticism that they would be.

Abstract:
The paper examines the role played by the parol evidence rule and integration when contracting parties are asymmetrically informed. The paper shows that by integrating an agreement, an uninformed party can better induce information disclosure from an informed party by penalizing non-disclosure and limiting the informed party's ex post opportunistic behavior. The paper also shows that when writing a complete contract is costly, the parties will rely on an oral promise backed by a sufficiently high liquidated damages in a partially integrated or unintegrated contract. This finding implies that the anti-penalty doctrine in contract law can either inefficiently force the parties to complete the contract or even undermine information disclosure.

integration, parol evidence rule, incomplete contracts

Abstract:
The paper examines the equilibrium quality of mass market contract terms, such as those in end user license agreements, when consumers can read and search for a better set of terms. Firms compete over price and quality of the terms. They can also choose to disclose (speak) the terms to consumers at cost. While all consumers must incur positive search (reading) cost to understand the terms, not everyone cares about the terms equally and they can also buy without reading. The paper examines two legal regimes: one that imposes a duty to read on the consumers and the other that imposes a duty to speak (disclose) on the firms. While neither regime strictly dominates the other in terms of social welfare, the paper shows that (1) as the reading or speaking cost converges to zero, the social welfare continuously converges to the first best; (2) consumers will have different preferences over duty-to-speak and duty-to-read regimes; and (3) the quality of the terms of non-disclosing firms may be higher. The results are consistent with the current chasm among scholars and courts over mandatory disclosure policy and also with the recent empirical findings.

shrink-wraps, EULA, quality search, duty to read, duty to speak

Abstract:
We demonstrate how a golden parachute can be used to improve the target shareholders' net return by partially shifting the managerial compensation burden to the buyer through a higher acquisition price. Consistent with the empirical observations, we show that (1) the golden parachute will be contingent on a change-of-control rather than solely on the manager's layoff, (2) the golden parachute will be promised early, for example, at the time of the manager's employment, not just in the face of a takeover or a merger, (3) the shareholders would want to extend its coverage to other employees, and (4) the size of the parachute can be much larger than the manager's annual compensation. We also examine the effect of a golden parachute on the managerial incentive scheme.

Abstract:
When a seller encumbers a property with a right of first refusal, whenever a third party offers to purchase the property, the right-holder can acquire the property by simply matching the third party's offer. I model the right as a modified auction where the right-holder gets to observe the third party's bid before making his own. I show that, compared to the standard auctions, the right increases the joint profit of the seller and the right-holder by reducing the third party's profit. This result is independent of whether the third party is aware of the right's existence and whether the right creates a welfare loss.