RICHARD SQUIRE, Fordham Law School
Email: rsquire@law.fordham.edu

Modern finance is increasingly dominated by contracts such as credit default swaps, put options and loan guaranties. These contracts create “contingent� liabilities, which become payable only upon the occurrence of an uncertain future event. This Article identifies a pervasive opportunism hazard presented by contingent liabilities that lawmakers and scholars have overlooked. If a contingent liability is especially likely to be triggered when the liable firm is insolvent, the contract that creates the liability transfers value from the firm’s creditors to its shareholders. Firms thus have incentive to engage in correlation-seeking—that is, to incur contingent debt that correlates, or through asset purchases can be made to correlate, with their insolvency risk. An example is AIG, which collapsed because it bought up assets that were likely to lose value just as large liabilities on its credit default swaps were triggered. Such conduct generates social costs such as overinvestment, more frequent financial distress, and potential systemic risk.

Despite these costs, legal doctrines that aim to protect creditors ignore matters of correlation. Such measures instead analyze contingent liabilities under principles designed to prevent misuse of “fixed� liabilities such as simple loans. But these principles provide almost no basis for distinguishing opportunistic contingent liabilities from those that are benign. This is especially problematic because correlation-seeking can cause a contingent liability to produce a much larger opportunistic transfer than would a fixed liability of equal face value. Lawmakers thus should redesign key legal doctrines to reflect the essential economic differences between contingent and fixed debt.

HAZEL V. J. MOIR, Regulatory Institutions Network, ANU
Email: hazel.moir@anu.edu.au

Public choice theory provides a parsimonious explanation of changes in public policy, yet there is little systematic data available about the major beneficiaries of patent systems. This paper uses data from the US and Australia to identify those companies which own the largest number of patents from applications made between 1990 and 2001. In both countries the 100 companies owning the most patents own about one-third of all patents owned by organisations. Forty-six companies - many of them household names - are among both the top 100 US patenters and the top 100 Australian patenters. Forty-six companies are on both lists. Among the top 100 US patenters, 43 are US-based. In Australia only one of the top 100 patenters is an Australian company. Major patenters are selective in the technologies they patent in Australia - few semi-conductor companies take out Australian patents, while pharmaceuticals and chemicals have a larger share than in the USA.

Twelve of the 13 companies that played a major role in the development of the TRIPS agenda have been among the top 100 US patenters. However data on the top 10 US patenters from 1969 to 2006 show that since the mid 1980s - the very time when US patent policy was extending to achieve a global reach - overseas companies replaced US companies as the dominant US patenters.

WEI CUI, China University of Political Science and Law
Email: wei.cui@post.harvard.edu

This paper develops a theoretical framework for analyzing the corporate income taxation of state-owner enterprises (SOEs). SOEs are subject to income taxation in many countries, presenting a puzzle as to why a government would tax its SOEs in lieu of simply requiring distributions. I suggest that for SOEs and private firms alike, divergent interests between managers and shareholders imply that ensuring optimal payout policy is not costless. To the extent that the solutions for mitigating this agency problem in the private firm context cannot be adequately implemented for SOEs, taxing SOEs constitutes a mechanism for forcing distributions. This explanation of SOE taxation implies that SOEs may be sensitive to the income tax, contrary to the supposition of some economists and legal scholars. Although SOEs may be less tax-sensitive than private firms in certain circumstances, and although they can be made less tax-sensitive if the government shareholder gives SOE managers “credit� for tax paid, these depend on contingent factors. I discuss these factors by borrowing elements of the framework developed by Chetty and Saez (2007) for analyzing the incentives of managers with respect to dividend payout. Moreover, I present non-quantitative empirical evidence from China suggests that SOEs may be rather tax-sensitive, which means that forcing distributions from them through the income tax may inflict tax distortions on the public sector.

KONG-PIN CHEN, Academia Sinica - Research Center for Humanities and Social Sciences, National Taiwan University - Department of Economics
Email: kongpin@gate.sinica.edu.tw
TSUNG-SHENG TSAI, National Tsing Hua University - Department of Economics
Email: tstsai@mx.nthu.edu.tw
ANGELA LEUNG, affiliation not provided to SSRN
Email: leungwa@aston.ac.uk

Judicial torture to extract information or elicit confession was a common practice in pre-modern societies, both in the East and the West. Moreover, often it was applied not only on the suspects, but also on the witnesses and plaintiffs as well. This paper proposes a positive theory for judicial torture. It is shown that torture reflects the magistrate's attempt to balance type I and type II errors in decision-making, by forcing the guilty to confess with higher probability than the innocent, and thereby decreases type I error at the cost of type II error. In that case, torturing the witnesses or the plaintiff might also serve the same function, as it helps to screen the cases so that only those with greater merits enter the court. When the information revealed during investigation improved as a result of technological advance, a judicial system based on torture became inferior to one based on evidence. This result is then used to explain the historical development of the judicial system.

SAMPSA SAMILA, Brock University
Email: sampsa.samila@brocku.ca
OLAV SORENSON, Yale School of Management, Rotman School, University of Toronto
Email: olav.sorenson@yale.edu

We find that the enforcement of non-compete clauses significantly impedes entrepreneurship and regional growth. Based on a panel of metropolitan areas in the United States from 1993 to 2002, our results indicate that, relative to regions in states that enforce non-compete covenants, an increase in the local supply of venture capital in states that restrict them has significantly stronger positive effects on (i) the number of patents, (ii) the number of firm starts, and (iii) employment. We address potential endogeneity issues in the supply of venture capital by using endowment returns as an instrumental variable. Our results point to a strong interaction between financial intermediation and the legal regime in promoting entrepreneurship and growth.