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Abstract:
This paper empirically examines the agency problems associated with the use of soft dollars in delegated portfolio management. We assume that active portfolio managers are hired to identify private information about mispriced securities, but in the absence of careful monitoring by investors or compensating organizational arrangements they will have too little incentive to do the necessary research. To the extent they nevertheless succeed in identifying mispriced securities, much of the value of the information can be lost to market interlopers due to low-quality broker executions. We develop two agency cost hypotheses for the role soft dollars play in active portfolio management. One hypothesis views soft dollars as a symptom of agency costs that allows money managers to unjustly enrich themselves at portfolio investors' expense. The other hypothesis views soft dollars as a method of reducing agency costs by encouraging optimal research and enforcing property rights to private information by bonding the quality of broker executions. Using a database of institutional money managers, we find that soft dollar use is positively related to different measures of risk-adjusted performance, suggesting that soft dollars reduce agency costs when other controls are uneconomic. Moreover, soft dollar use is unrelated to management fees, suggesting that managers do not use soft dollars to unjustly enrich themselves.

Abstract:
We distinguish between discovery information and private foreknowledge in the valuation of initial public offerings of corporate securities. An underwriter gathers discovery information to value and price the issue. The issuing firm relies on this information to make the optimal investment decision. In the absence of syndicate restrictions, the inevitable errors in pricing give outsiders the opportunity to acquire private foreknowledge to effect wealth transfers from the underwriter. Because this activity is costly but has no influence on the issuer's investment, it reduces the parties' joint wealth. They therefore have an incentive to organize their arrangements to avoid the associated losses. We show how various features of the syndicate system perform this function, increasing the returns to investment banking and decreasing the cost of capital to issuing firms.

Abstract:
For the first time in over six decades, recent Supreme Court decisions confirm that federal regulatory authority under the Commerce Clause truly is limited. These decisions coincide with an increasing appreciation among scholars and jurists for the concept of competitive federalism. This paper derives the implications of competitive federalism for federal antitrust jurisdiction under the Sherman Act. It provides a clear and substantively reasoned jurisdictional test based on the concept of geographic market power familiar to antitrust scholars, practitioners, and regulators in evaluating horizontal mergers. According to this test, to be subject to federal antitrust jurisdiction Sherman Act defendants must have a sufficiently large share of the geographic antitrust market that they can plausibly exercise market power that has a substantial effect on prices "in more states than one." This test reflects a natural progression in the evolution of Sherman Act and Commerce Clause jurisdiction. It resolves a number of troubling inconsistencies in the case law and also provides a useful roadmap for the direction the Court's general Commerce Clause jurisprudence might take in other areas of federal regulation.

competitive federalism, antitrust, legal evolution, geographic markets

Abstract:
All humans and the institutions they create err from time to time. Regulatory agencies are no exception. This essay hypothesizes that by failing to recognize mutual fund abnormal returns as an open-access common pool subject to a race to first possession, the U.S. Securities and Exchange Commission has fundamentally misunderstood the nature of the conflicts of interest said to plague the industry. As a result, its regulatory response to the recent wave of mutual fund scandals, including rule making and civil actions, fails to maximize the institutional value of mutual funds as a savings vehicle. I rely on the property rights approach to economic theory to derive testable implications and recommend structural reforms to ensure that regulatory error is internally corrected by the common law process of adjudication and appellate review.

conflicts of interest, mutual funds, open access, common pool, market timing

Abstract:
With soft dollar brokerage, institutional portfolio managers pay brokers "premium" commission rates in exchange for rebates they use to buy third-party research. One hypothesis views this practice as a reflection of the agency problem in delegated portfolio management; another views it as a contractual solution to the agency problem that aligns the incentives of investors, managers, and brokers where direct monitoring mechanisms are inadequate. Using a database of institutional money managers, we find that premium commission payments are positively related to risk-adjusted performance, suggesting that soft dollar brokerage is a solution to agency problems. Moreover, premium commissions are positively related to management fees, suggesting that labor market competition does not punish managers for using soft dollars.

Portfolio choice, Investment Decisions

Abstract:
This paper develops a clear and substantively reasoned test for Sherman Act jurisdiction based on the interstate exercise of market power. According to this test, to establish jurisdiction under the Act the plaintiff must allege that, if successful, the defendants' conduct is reasonably likely to raise prices "in more states than one." Local trade restraints that cannot plausibly be alleged to raise prices outside the home state therefore lie beyond the reach of the Sherman Act. The geographic market power test resolves a number of troubling anomalies in the case law on Sherman Act jurisdiction. It also takes seriously the Act's acknowledged goal of promoting consumer welfare and preserves the states' role as laboratories for political competition in our federal system of dual sovereignty.

Abstract:
This research investigates the hypothesis that prior to British sovereignty the native tribes of the Northwest Coast of North America established sophisticated property rights institutions to encourage efficient husbandry of the region's salmon fisheries. The hypothesis asserts that to the extent tribal property rights to salmon streams were clearly defined and enforced tribal leaders had the incentive to maximize the present value of expected returns to the streams under their exclusive control. As rational maximizers they would very likely have invested resources to accumulate private stream-specific knowledge of salmon husbandry. Husbandry could have included selection in favor of preferred biological characteristics such as larger average fish size, larger population size, reduced run variability, advantageous run timing, and home stream loyalty. In many cases, the resulting biological adaptations might have evolved unconsciously, but in other cases they would have had to be the result of counter-intuitive, and therefore purposeful, genetic selection by tribal leaders. The available evidence is broadly consistent with the salmon husbandry hypothesis. This research has important implications for the resolution of native land claims, the formulation of rational environmental policy, and understanding the evolution of customary law. It also sheds light on the conditions under which an early breakthrough in scientific knowledge might lead to dramatic and predictable institutional change.

Abstract:
Mutual funds stand ready at all times to sell and redeem common stock to the investing public for the net value of their assets under management. In the language of transaction cost economics, they are open-access common pools subject to virtually free investor entry and exit. The Investment Company Act (1940) requires mutual funds to be managed by an outside advisory firm pursuant to a written contract, which normally pays the adviser a small share of net asset value, say, one-half of one percent per year. Following 1970 amendments to the Investment Company Act imposing a fiduciary duty on advisers with respect to their receipt of compensation, a large number of private civil suits attempting to recover excessive fees have been filed against advisory firms. By failing to account for the transaction costs inherent in mutual fund organization, Congress, securities regulators, financial scholars, and even courts have misidentified a conflict of interest with respect to fund advisory fees, encouraging these frivolous suits. With free investor entry and exit and rational expectations, fund flows endogenize investor returns. Regardless of the level of the advisory fee, any expected abnormal return to a manager’s superior stock-picking skill will be competed away by investors chasing the prospect of capturing the associated rents. With shareholders having a common claim to fund assets, all expected rents will be either transferred to the manager in the form of higher total fee payments on a larger asset base or dissipated by added administrative costs. As a first approximation, the level of advisory fees is therefore irrelevant to fund shareholders. The best they can expect from placing their money in a managed fund is a normal competitive return after adjusting for risk and other factors. With the U.S. Supreme Court having recently granted certiorari in an excessive fee case appealing an arguably maverick opinion by Judge Frank Easterbrook of the Court of Appeals for the Seventh Circuit, it is essential that various myths about mutual fund fees be exposed to careful economic analysis.

efficiency wage, Gartenberg v. Merrill Lynch, quality assurance, SEC, scale economies, Securities and Exchange Commission, Wharton Report

Abstract:
Canada now faces two looming policy crises that have come to a head in British Columbia. The first is long-term depletion of the Pacific salmon fishery by mobile commercial ocean fishermen racing to intercept salmon under the rule of capture. The second is an unsettling series of native land claims resulting from Canadian Supreme Court case law recognizing and affirming "the existing aboriginal and treaty rights of the aboriginal peoples of Canada." This essay relies on the economics of property rights to propose a privatization auction of the salmon fishery while promoting the Canadian commonwealth and respecting the tribes' distinctive aboriginal culture.

Abstract:
This paper relies on the economics of transaction costs to assess the likely effect on investor welfare of the U.S. Securities and Exchange Commission's (SEC's) prohibition on an innovative business practice known as directed brokerage. Its key insight is that the quality of a broker's execution of portfolio trades is difficult for a mutual fund adviser to assess until it is too late - that is, execution quality is an experience good. In the meantime, low-quality brokerage can substantially reduce investor returns. To have the incentive to provide high-quality execution, a broker must expect to receive a stream of premium portfolio commissions in excess of his execution costs, much along the lines of a Klein-Leffler quality-assuring price premium. Competition between brokers for premium commissions leads them to post a performance bond with advisers equal to the present value of the expected premium stream. With directed brokerage, the bond takes the form of up-front broker effort devoted to marketing the fund's retail shares. Once having posted the bond, any broker that provides low-quality execution will eventually be terminated by the adviser and lose the premium stream that provides a normal return on the up-front bond. Low-quality brokerage is thus screened out. Contrary to its intended effect, the SEC's prohibition on directed brokerage likely reduces investor welfare by failing to recognize the problems inherent in transacting experience goods.

adverse selection, advisory contract, bundling, commissions, conflicts of interest, directed brokerage, institutional brokerage, incentive alignment, investor welfare, Klein-Leffler, mutual fund, performance bond, quality assurance, SEC, transaction costs, unjust enrichment, vertical arrangements

Abstract:
After some two years of deliberations, in July 2006 the SEC released its long-awaited Guidance on the scope of the soft dollar safe harbor. Passed as part of the Securities Acts Amendments in May, 1975, the safe harbor has protected fund advisers and other money managers for over 30 years from criminal actions and civil suits for breach of fiduciary duty when they use client assets to pay more than the lowest available brokerage commissions in exchange for brokerage and research services. During this time the SEC has interpreted and re-interpreted the safe harbor's scope, largely owing to the public controversy soft dollars engender as a form of illicit kickback designed to subvert advisers' loyalty. The SEC's 2006 Guidance attempts to dramatically narrow the permissible use of soft dollars by prescribing a laundry list of protected and unprotected services. Yet the SEC is now considering further interpretation, and its chairman has petitioned Congress for an outright repeal of the soft dollar safe harbor. This paper shows that soft dollars are an innovative and efficient form of economic organization that benefits fund investors. According to economic theory now well-established in antitrust law, the SEC's Guidance is hopelessly misguided. Were the Guidance to come under the scrutiny of a federal court, the SEC would very likely experience another in its recent string of embarrassing legal defeats.

adverse selection, advisory contract, bundling, conflicts of interest, fiduciary duty, institutional brokerage, incentive alignment, investor welfare, kickback, payola, performance bond, quality assurance, safe harbor, SEC, transaction costs, unjust enrichment, vertical arrangements

Abstract:
We view debt and outside equity as serving to elicit credible information from different specialists about the value of an enterprise in its various uses. The equity valuation specialist provides a price forecast for equity that reveals information about the value for the enterprise in its primary use. The debt valuation specialist provides a price forecast for debt that reveals information about the value of the enterprise in its alternative use. The prices forecast by the valuation specialists credibly reveal their private information because they are required to buy the associated claims at the forecast prices, thereby bonding their valuations.

Abstract:
We model the role various forms of nonrecourse secured debt play in efficiently allocating control rights over assets whose value is state-specific. Ex ante, the entrepreneur makes a noncontractable investment that is specific to the best use of the asset in the status quo, or good, states. The lender makes a noncontractable investment in redeployment that is specific to the next best use of the asset in the bad states. The face amount of the loan is chosen to equal the value of the asset in the critical state that separates the good and bad states, with the loan being secured by the asset. If a good state prevails, the entrepreneur maintains control and captures the entire surplus from his use of the asset. If a bad state prevails, he defaults and relinquishes the asset because it is worth less to him than his obligation under the loan. The lender then redeploys the asset to its next best alternative use and captures the entire surplus from doing so. This state-contingent transfer of control avoids the ex post bargaining that wold otherwise split the redeployment surplus between the parties and distort their ex ante specific investments. Unlike other prominent models of financial contracting, ours imposes no wealth constraint on the entrepreneur and requires no intermediate signal to identify the ex post state of the world. Moreover, it is consistent with a wide range of financial practices including financial leasing, real options, vendor financing, secured and unsecured debt, project finance, and the general pattern of debt priorities and their disposition in bankruptcy.

Abstract:
This paper presents a unified theory of debt and outside equity based on specialized valuation of the corporate enterprise. We model the decision of an entrepreneur to use debt and equity finance to get credible information from different specialists about the value of the enterprise in various uses across alternative states of the world. The equity valuation specialist -- who could be a venture capitalist or another type of equity partner -- provides a price forecast for equity that reveals demand-side information about the value of the enterprise in the good sates. His equity share represents a claim on the cash flow generated by the enterprise in its primary use. The debt valuation specialist provides a price forecast for debt that reveals information about the value of the enterprise in the bad states. His loan represents a claim on the cash flow generated by the enterprise if redeployed to its next best use. The prices forecast for debt and equity by the valuation specialists credibly reveal their private information because the entrepreneur requires them to buy the associated claim at the forecast price, thereby bonding their valuations. In contrast to recent work on the role of debt and outside equity in communicating supply-side information to outside investors, we focus on the communication of demand-side information to the entrepreneur. We provide testable implications that conflict with those provided by accepted informational explanations for debt and outside inquiry.

Abstract:
This paper provides an explanation for the increase in firm value observed upon spin-off that is based upon the transmission of information about the various assets (or divisions) of a firm from informed to uninformed investors. Spin-offs serve to transmit information from informed to uninformed investors by increasing the number of traded securities, from whose prices uninformed investors can infer part of the private information of informed investors. The additional information made available to uninformed investors improves their estimates of, and decreases their uncertainty about value of the assets of the firm. It thus increases their demand for the securities issued by the firm in the presence of positive information about the value of the assets of the firm, in turn increasing the price of these securities and the value of the firm. The increase in firm value made possible by a spin-off is shown to be related to the amount of trading that follows the spin-off, as uninformed investors increase their total holdings of the various securities. The private information made available to uninformed investors is also made available to managers, who are thereby enabled to make better investment decisions.

Abstract:
This paper provides a common explanation for a variety of asset financing arrangements that are observed in practice, specifically leasing, secured debt, project finance without recourse, and vendor financing. Such arrangements are viewed as serving to allocate ownership of one or many assets to those users best able to make use of these assets, in a manner that precludes ex-post bargaining and therefore avoids the distortion of ex-ante investment. The paper also provides a partial explanation for the various levels of seniority of debt.

Abstract:
We present an information-based explanation for spinoffs. When the various divisions of a firm are spun off into several firms that have separate stock market listings, the number of traded securities increases. This makes the price system more informative. It improves the quality of the investment decisions made by managers, and reduces uninformed investors' uncertainty about the value of the divisions. Both effects serve to increase the sum-total of the market values of the spun-off divisions above the market value of the original firm.