Irredeemably Inefficient Acts: A Threat to Markets, Firms, and the Fisc

Abstract

This Article defines and explores irredeemably inefficient acts — a conceptually distinct and empirically important category of socially undesirable conduct. Though inefficient behavior is, no doubt, pervasive, the standard view holds that inefficient conduct may be converted into efficient behavior by forcing actors to internalize the external harms of their decisions. For some acts, however, such conversion is impossible. These acts are not just inefficient forms of otherwise socially beneficial activities — they are not just contingently inefficient. Rather, they are inefficient at their core; they reduce social welfare no matter what the regulator does. These irredeemably inefficient (or just irredeemable) acts are private, intentional, non-consensual transfers of money. While this definition clearly describes theft, it also covers churning and price fixing, market manipulation and option backdating, insider trading and tax shelters, to name just a few examples. All these acts are socially undesirable in any form and at any level because though the money transfer is generally welfare-neutral, transferors and transferees waste real resources to make sure that this transfer does, or does not, occur. Yet irredeemable acts may be overdeterred if enforcement is imperfect. Overdeterrence is possible for two reasons. First, enforcement increases the costs of irredeemable acts that remain undeterred. Second, enforcement burdens efficient conduct that yields outcomes indistinguishable from those produced by irredeemable acts. These considerations (along with the irrelevance of a standard cost-benefit comparison) underlie the unique optimal deterrence analysis of irredeemable acts. Antitrust law, corporate law, and criminal law largely reflect the divide between contingently and irredeemably inefficient acts, as well as some of the more specific prescriptions following from this Article’s inquiry. Securities and commodities regulation fails to recognize the same distinction despite a wide variety of irredeemable acts in securities and commodities law violations. Although the tax policy implications of the proposed framework are limited, this framework helps to resolve a long-standing debate about tax shelter regulation. Overall, the proposed analysis enriches our understanding of socially undesirable conduct, supports numerous rules and sanctions across divergent areas of economic regulation, and animates a call for legal reforms.

Keywords: Optimal Deterrence, Rent Seeking, Theft, Insider Trading, Securities Fraud, Price Fixing, Tax Shelters, Economic Substance, Graduated Penalties

JEL Classification: K14, K21, K22, K34, K42, H26