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Abstract:
The private ordering literature examines how nongovernment institutions mitigate opportunistic behavior in transactions. It emphasizes two elements that facilitate cooperation and reduce opportunism: repeated play and reputation. This paper explores the implications of a third element: network effects. Network effects create an incentive for a unique form of opportunism that exists only in network environments - degradation. On the other hand, network effects facilitate mechanisms that may be very effective in mitigating opportunism. Therefore, in certain industries, networks mitigate opportunism, largely displacing in that role the parties to the transaction and the government. This paper identifies mechanisms used by networks to reduce opportunism, and market characteristics that are conducive to the effectiveness of these mechanisms (and therefore to the efficiency of networks as regulators). This helps explain the prevalence of networks in certain markets as compared to others, and gives tools to assess networks' ability to self-regulate and anticipate the type of opportunism that is more likely to plague a given environment.

private legal systems, private ordering, networks, network effects, self-regulation, institutions, governance, transaction costs, reputation, regulation

Abstract:
Scholarship on private legal systems (PLS) explains the evolution of norms created and enforced by PLSs, but rarely addresses the evolution of institutions that form PLSs. Such institutions are assumed to form spontaneously (unless suppressed by law) when law is either unresponsive or incapable of directing behavior in welfare-maximizing manners.

But, as this paper demonstrates, PLSs typically cannot form spontaneously. Newly formed PLSs cannot enforce cooperation since the effectiveness of mechanisms used to secure this cooperation (e.g., the threat of exclusion) depends on the PLS's ability to confer benefits to its members, and newly formed PLSs do not yet confer such benefits.

Successful PLSs bypass this barrier by building on extant foundations - preexisting institutions that already benefit members, typically through functions requiring less costly enforcement. The threat of losing preexisting benefits disciplines members to abide by the PLSs' rules, which in turn allows the PLSs to regulate behavior. This pattern indicates that rather than developing spontaneously, PLSs develop in phases, initially facilitating activities that are unrelated to regulating behavior and incur lower enforcement costs, the provision of which enables the PLS to regulate behavior in the second stage. The paper suggests normative applications of this observation in the fields of antitrust, critical infrastructure protection and corporate governance.

Abstract:
This note is designed to explain basic concepts of the economic theory of the firm to students who have no background in economics. It does not purport to cover all or even most of the scholarship in the field, nor does it aim to provide new insights into the theory of the firm. I find this note to be a useful teaching tool in introductory organizational law courses. The note is copied from: Amitai Aviram, Unincorporated Business Entities: Course Material.

Abstract:
When deciding whether to share information, firms consider their private welfare. Discrepancies between social and private welfare may lead firms excessively to share information to anti-competitive ends - in facilitating of cartels and other harmful horizontal practices - a problem both antitrust scholarship and case law have paid much attention to. On the other hand, legal scholars have paid far less attention to the opposite type of inefficiency in information sharing among competitors - namely, the problem of sub-optimal information sharing. This phenomenon can generate significant social costs and is of special importance in network industries because the maintenance of compatibility, a key to producing positive network effects, typically requires information sharing. Understanding the hitherto neglected impact of sub-optimal information sharing is important not only for many areas of antitrust law, but also for developing effective policies towards network industries and critical infrastructures more generally, as well as for improving those procedural rules that concern information exchange among litigating parties.

This paper therefore advances the legal analysis of impediments to efficient information sharing in a number of significant ways: First, it shows that the strategic behavior of competitors may erect an economic barrier to information sharing that has not been previously addressed in the literature - the fear of degradation. This form of strategic behavior involves the strategic refusal to share information when the refusal inflicts a greater harm on one's rivals than on oneself, and thus generates a competitive advantage. Second, the paper reveals a hitherto unrecognized set of behavioral impediments to information sharing, wherein rivalry norms and managers' risk attitudes bias competitors' judgments of the prospects of information sharing and the status-quo bias and ambiguity aversion lead these decision makers to avoid such arrangements. Third, it integrates these economic and behavioral insights with the findings of the extant literature to create a new framework for predicting when private information sharing will be suboptimal. Finally, we suggest how the alignment of private information sharing with social optimality may be promoted, based on the framework developed here.

Abstract:
This paper is a specialized version, abbreviated and focused on application to critical infrastructure protection, of our paper titled "Overcoming Impediments to Information Sharing." Impediments to information sharing between firms operating critical infrastructure have been identified as a key security concern in the recently promulgated National Strategy for the Physical Protection of Critical Infrastructures and Key Assets. This paper identifies economic and behavioral impediments to information sharing among rivals in general, and rivals operating critical infrastructure in particular. The paper then assesses conditions affecting the severity of these impediments. Finally, the paper takes first steps in developing a framework that will predict more accurately when private information sharing would be suboptimal and suggest how better to align private information sharing with social optimality.

Information sharing, information exchange, antitrust, cooperation, collective action, degradation, norms, rivalry, risk, loss aversion, omission bias

Abstract:
Much of legal scholarship, and in particular Law and Economics, evaluates law and predicts its effects based on an analysis of law's manipulation of individuals' incentives. Although manipulating incentives certainly explains some of law's impact on behavior (e.g., increasing airport security may deter some airplane hijackers), law has an equally important impact on behavior by manipulating perceptions (e.g., causing the public to believe that the risk of airplane hijacking has diminished as a result of the law that increased airport security).

Thus, like the placebo effect of medicine, a law may impact social welfare beyond its objective effects by manipulating the public's subjective perception of the law's effectiveness. Failure to consider this largely ignored legal placebo effect may cause significant overstatement or understatement of a law's benefits.

By shedding light on laws' effects on perceptions, this Article reveals forces that shape the creation of law. Legal placebo effects are a method by which politicians extract private benefits from the identification and mitigation of gaps between real and perceived risks. Some private entities compete with lawmakers through extra-legal methods. This competition affects laws' subject matter and the manner in which laws are presented to the public.

cognitive bias, behavioral law & economics, risk

Abstract:
The enforcement of certain norms on network participants - such as norms supporting information exchange and governing access to the network - is critical in ensuring the security of the network. While a public norm enforcer may be feasible in many situations, private norm enforcement may, and frequently does, complement or substitute public enforcement. Private enforcement of cyber-security is often subsidized, primarily in non-pecuniary manners (e.g., by exemption from antitrust laws). These subsidies may be necessary to capture the positive externalities of providing security to the network, but they also bias private parties' incentives and may result in the formation of inefficient security associations that are beneficial to their members only due to the subsidy. To mitigate this concern, subsidies should be awarded only to associations that are likely to be effective in enforcing norms on the network participants. This Article offers a framework that assesses the likelihood that an association would become an effective norm enforcer.

Norms that are expensive to enforce are rarely enforced by newly-formed private legal systems (PLSs), because the effectiveness of mechanisms used to secure compliance (e.g., the threat of exclusion) depends on the PLSs' ability to confer benefits on their members, and newly-formed PLSs do not yet confer such benefits. Pre-existing functionality inexpensively enhances a PLS' ability to enforce norms, and therefore most PLSs rely on preexisting institutions that already benefit members, typically by regulating norms that are not very costly to enforce. The threat of losing these benefits disciplines members to abide by the PLS' rules, thus permitting the PLS to regulate behavior.

Network security norms are usually expensive to enforce, and thus a private association enforcing them would be more successful and thus more deserving of public subsidies if it relied on a suitable pre-existing functionality. The Article suggests criteria for assessing the effectiveness of pre-existing functionalities.

Abstract:
In Organizational Misconduct: Beyond the Principal-Agent Model, Professor Krawiec argues that organizations have perverse incentives to implement ineffective compliance programs, and supports this argument with a survey of empirical research. Based on her argument she urges that organizations be held strictly liable to corporate crimes (in terms of both guilt and punishment), regardless of the implementation of a compliance program by the accused organization. Assuming arguendo that criminal law's current treatment of compliance programs gives organizations an incentive to design inefficient programs, this Article posits that corporate crime may be better deterred if criminal law embraces, rather than remains agnostic to, compliance programs.

First, Krawiec's policy suggestion overstates the impact of the legal sanction on corporate behavior. The legal sanction is only one of several sanctions imposed for organizational misconduct. The public relations effect of misconduct may harm organizations more than any legal sanction, giving them an incentive to implement compliance programs that assure the public of the organization's compliance with the law. Second, Krawiec does not consider utility that is derived from reducing the public's subjective perception of the likelihood of misconduct. This placebo effect that exists whether a compliance program is objectively effective or not, may increase utility by offsetting behavioral biases that cause the public to overestimate the probability of organizational misconduct.

Abstract:
This paper examines temporal aspects of market power. It explores an industry - the Israeli PVC industry - in which the dominant firm's market power fluctuates cyclically, and identifies the conditions that result in such phenomena.

The existence of cyclical market power may lead the market participants to strategic behavior that is markedly different from that in markets with either steady market power or constantly declining market power. It is suggested that in markets characterized by cyclical market power, a dominant firm may find it both possible and profitable to combat the cyclical decline in its market power by "temporal leveraging" of its market power: policing a cartel in the downstream market in return for exclusivity in sales to the cartel members. Such a scheme may resist the criticism against the plausibility of most types of monopoly leveraging and exclusive dealing.

market power, monopoly leveraging, antitrust, cyclical, temporal, dumping, PVC

Abstract:
Corporate and securities laws are seen to mitigate corporate fraud by 'manipulating the incentives of agents': presenting corporate agents with a probability of being caught and punished if they commit fraud. This article suggests that the same laws also affect corporate fraud in a significant but unappreciated manner, by 'manipulating the perceptions of the principals': affecting the principals' efforts in monitoring the agents by making them perceive the risk of fraud as more or less likely.

Due to several cognitive biases discussed in this article, principals misperceive the risk of fraud by their agents in a cyclical manner: they under-estimate the likelihood of fraud during booms and over-estimate it following busts. As a result, they insufficiently police the agents during booms and excessively do so during busts.

Conspicuous law enforcement triggers cognitive biases that could be thoughtfully used to counter the public's cyclical bias. But political pressures that prosecutors face, as well as their failure to consider law enforcement's effect on principals' perceptions, result in enforcement that is itself cyclical and may exacerbate the biased perception of the risk of fraud.

Monetary policy is analogous in requiring counter-cyclical government intervention, and central banks have successfully stepped up to the task despite facing similar pressure not to intervene counter-cyclically. This article concludes by examining whether institutional safeguards that free central banks to operate counter-cyclically can be adapted to the context of corporate fraud.

optimal deterrence, optimal enforcement, cognitive bias, behavioral law & economics, corporate fraud, monetary policy, central bank

Abstract:
The network facilities of many network industries are natural monopolies. It is well accepted, however, that certain network industries may efficiently accommodate competition between several firms over the utilization of the network facilities. Historically, many networks had been created by a single firm, and introducing competition into such networks often requires compelled accommodation of a new competitor into a network dominated by an incumbent.

This paper studies one case of compelled accommodation in a networks industry - the introduction of a second processor of Visa-brand credit cards in Israel. The paper does not attempt to offer a theory on this matter, but rather provides a detailed case study that should assist in establishing an empirical basis to theories on government's role in introducing competition into a network industry.

Credit cards

Abstract:
The production of law - including the choice of a law's subject matter, the timing of its enactment and the manner in which it is publicized and perceived by the public - is significantly driven by an extra-legal market in which politicians and private parties compete over the opportunity to engage in bias arbitrage. Bias arbitrage is the extraction of private benefits through actions that identify and mitigate discrepancies between objective risks and the public's perception of the same risks.

Politicians arbitrage these discrepancies by enacting laws that address the misperceived risk and contain a 'placebo effect' - a counter-bias that attempts to offset the pre-existing misperception. If successful, politicians are able to take credit for the change in the perceived risk, while social welfare is enhanced by the elimination of deadweight loss caused by the risk misperception.

However, politicians must compete with private parties such as insurers, experts and the media, who can engage in bias arbitrage using extra-legal means. This article analyses methods in which parties engage in bias arbitrage and the effect of interaction between potential bias arbitrageurs on the production of law.

Abstract:
Private legal systems ("PLSs") are to the universe of law as dark matter is to the physical universe: while PLSs are invisible to the casual study of law, they are observable by their impact on individuals' behavior and by their interaction with the public legal system. PLSs expand to fill voids where the public legal system cannot or does not wish to enforce norms, and contract when the public legal system moves to displace them. But the public legal system is not the only force shaping the course of PLSs' development.

This chapter identifies two other forces that significantly affect the evolution of PLSs. The first - incumbent's enforcement advantage - impacts the identity of the PLS that will enforce the norm. The second - bias arbitrage - impacts the type of norms the PLS would choose to enforce. These forces challenge both parts of an idealized notion that PLSs form spontaneously (without reliance on pre-existing institutions) to enforce norms that maximize their members' welfare.

Due to the influence of incumbent's enforcement advantage, PLSs tend to begin their life enforcing a core norm that has very low enforcement costs (typically, providing social or spiritual services). Once this core has developed, PLSs may then choose expansion norms that can be more expensive to enforce, and that benefit from the PLS's ability to compel compliance with the new norm by denying a member the benefits of its enforcement of the core norm and any expansion norms already successfully enforced. The expansion norms that are chosen will not necessarily be those that maximize the social welfare of PLS members. Rather, the PLS's will often attempt cause its member to perceive it as valuable by conducting bias arbitrage through enforcing norms that address risks that its members significantly over-estimate.

Abstract:
The agency problem at the core of corporate law stems from a chronic potential conflict of interest between directors’ self-interest and that of shareholders. Corporate law views directors’ self-interest in terms of diverting welfare to directors at the expense of shareholders. Another component of directors’ self-interest – being perceived as maximizing shareholders’ welfare – is seen not as part of the agency problem but as part of the solution (aligning directors’ incentives with shareholders’).

This is true only if taking actions that maximize shareholders’ welfare is also the optimal manner for a director to be perceived as maximizing welfare. However, directors have more appealing ways to be positively perceived. In conducting bias arbitrage, directors identify risks that shareholders over-estimate, take action to address the risk, and then take credit for the “lowered” risk (i.e., shareholders’ corrected assessment of the risk).

Bias arbitrage is more attractive as shareholders’ misperception of a risk increases. The opportunity to bias arbitrage thus leads directors to address highly-misperceived risks instead of highly-remediable risks.

agency problem, corporate governance, conflict of interest, business judgment rule, bias arbitrage

Abstract:
Scholarship on private legal systems (PLS) explains the evolution of norms created and enforced by PLSs, but rarely addresses the evolution of institutions that form PLSs. Such institutions are assumed to form spontaneously (unless suppressed by law) when law is either unresponsive or incapable of directing behavior in welfare-maximizing manners.

But, as this paper demonstrates, PLSs typically cannot form spontaneously. Newly formed PLSs cannot enforce cooperation since the effectiveness of mechanisms used to secure this cooperation (e.g., the threat of exclusion) depends on the PLS's ability to confer benefits to its members, and newly formed PLSs do not yet confer such benefits.

Successful PLSs bypass this barrier by building on extant foundations - preexisting institutions that already benefit members, typically through functions requiring less costly enforcement. The threat of losing preexisting benefits disciplines members to abide by the PLSs' rules, which in turn allows the PLSs to regulate behavior. This pattern indicates that rather than developing spontaneously, PLSs develop in phases, initially facilitating activities that are unrelated to regulating behavior and incur lower enforcement costs, the provision of which enables the PLS to regulate behavior in the second stage.