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Abstract

This Comment provides an argument for applying a wellbeing-analysis approach to eminent domain compensation, discussing the inefficiencies that result from compensating individuals with only the fair market value of their properties and arguing that a well-being-analysis approach provides a way out of the practical compromises made in eminent domain jurisprudence. Although happiness regressions do not demonstrate the exact valuation that an individual has of her property, using a multiplier that reflects the average subjective premium generated by a happiness regression is consistent with value-of-life evidence, which uses information about others to estimate an average multiplier that ensures more-accurate damages.

This Comment demonstrates that the BHPS data set, along with certain assumptions about why individuals move, implies that a wedge exists between the subjective valuation of an owned property and its fair market value. Not only does this wedge exist but it measures somewhere around or above 22 percent of fair market value. Given such a potentially large effect, this Comment aims to inspire future survey work with respect to individuals who are required to move. Such survey data would measure changes in happiness when the move—since it is due to eminent domain—is exogenous. For this reason, regression analyses based on such moves will provide even more-accurate estimates for the average undercompensation that occurs when individuals are paid only the fair market value of their properties in the context of eminent domain.

Summary

In 2009, the U.S. Congress passed the “Durbin Amendment” to the Dodd-Frank financial reforms. In October 2011, the Durbin Amendment was implemented by a Federal Reserve rulemaking that effectively halved the debit card “interchange fee” that may be charged by banks with over $10 billion in assets. This paper assesses the emerging data on Durbin’s effects and provides an in-depth review of the actual U.S. experience with the Durbin Amendment.

The paper begins with a brief discussion of the role and benefits of payment cards. It then proceeds to a description of the Durbin Amendment’s interchange fee caps, followed by an assessment of the effect of the caps on bank customers, comparing the differential effect on customers of banks subject to the caps versus those that are not subject to them. This leads to a discussion of the wider effect of the caps, with particular focus on the effect on poorer households, on the quality of banking services, and on the usage of different types of payment cards.

An occasional reader brought to our attention a bill that is fast making its way through the U.S. House Committee on Financial Services. The Small Company Disclosure Simplification Act (H.R. 4167) would exempt emerging growth companies and companies with annual gross revenue less than $250 million from using the eXtensible Business Reporting Language (XBRL) structure data format currently required for SEC filings. This would effect roughly 60% of publicly listed companies in the U.S.

XBRL makes it possible to easily extract financial data from electronic SEC filings using automated computer programs. Opponents of the bill (most of whom seem to make their living using XBRL to sell information to investors or assisting filing companies comply with the XBRL requirement) argue the bill will create a caste system of filers, harm the small companies the bill is intended to help, and harm investors (for example, see here and here). On pretty much every count, the critics are wrong. Here’s a point-by-point explanation of why:

1) Small firms will be hurt because they will have reduced access to capital markets because their data will be less accessible. — FALSE
The bill doesn’t prohibit small firms from using XBRL, it merely gives them the option to use it or not. If in fact small companies believe they are (or would be) disadvantaged in the market, they can continue filing just as they have been for at least the last two years. For critics to turn around and argue that small companies may choose to not use XBRL simply points out the fallacy of their claim that companies would be disadvantaged. The bill would basically give business owners and management the freedom to decide whether it is in fact in the company’s best interest to use the XBRL format. Therefore, there’s no reason to believe small firms will be hurt as claimed.

Moreover, the information disclosed by firms is no different under the bill–only the format in which it exists. There is no less information available to investors, it just makes it little less convenient to extract–particularly for the information service companies whose computer systems rely on XBRL to gather they data they sell to investors. More on this momentarily.

2) The costs of the current requirement are not as large as the bill’s sponsors claims.–IRRELEVANT AT BEST
According to XBRL US, an XBRL industry trade group, the cost of compliance ranges from $2,000 for small firms up to $25,000–per filing (or $8K to $100K per year). XBRL US goes on to claim those costs are coming down. Regardless whether the actual costs are the “tens of thousands of dollars a year” that bill sponsor Rep. Robert Hurt (VA-5) claims, the point is there are costs that are not clearly justified by any benefits of the disclosure format.

Moreover, if costs are coming down as claimed, then small businesses will be more likely to voluntarily use XBRL. In fact, the ability of small companies to choose NOT to file using XBRL will put competitive pressure on filing compliance companies to reduce costs even further in order to attract business, rather than enjoying a captive market of companies that have no choice.

3) Investors will be harmed because they will lose access to small company data.–FALSE
As noted above,investors will have no less information under the bill–they simply won’t be able to use automated programs to extract the information from the filings. Moreover, even if there was less information available, information asymmetry has long been a part of financial markets and markets are quite capable of dealing with such information asymmetry effectively in how prices are determined by investors and market-makers.  Paul Healy and Krishna Palepu (2001) provide an overview of the literature that shows markets are not only capable, but have an established history, of dealing with differences in information disclosure among firms. If any investors stand to lose, it would be current investors in small companies whose stocks could conceivably decrease in value if the companies choose not to use XBRL. Could. Conceivably. But with no evidence to suggest they would, much less that the effects would be large. To the extent large block holders and institutional investors perceive a potential negative effect, those investors also have the ability to influence management’s decision on whether to take advantage of the proposed exemption or to keep filing with the XBRL format.

The other potential investor harm critics point to with alarm is the prospect that small companies would be more likely and better able to engage in fraudulent reporting because regulators will not be able to as easily monitor the reports. Just one problem: the bill specifically requires the SEC to assess “the benefits to the Commission in terms of improved ability to monitor securities markets” of having the XBRL requirement. That will require the SEC to actively engage in monitoring both XBRL and non-XBRL filings in order to make that determination. So the threat of rampant fraud seems a tad bit overblown…certainly not what one critic described as “a massive regulatory loophole that a fraudulent company could drive an Enron-sized truck through.”

In the end, the bill before Congress would do nothing to change the kind of information that is made available to investors. It would create a more competitive market for companies who do choose to file using the XBRL structured data format, likely reducing the costs of that information format not only for small companies, but also for the larger companies that would still be required to use XBRL. By allowing smaller companies the freedom to choose what technical format to use in disclosing their data, the cost of compliance for all companies can be reduced. And that’s good for investors, capital formation, and the global competitiveness of US-based stock exchanges.

Filed under: disclosure regulation, financial regulation, markets, Sykuta, truth on the market

On Wednesday, the U.S. Supreme Court heard oral argument in Halliburton v. Erica P. John Fund, a case that could drastically alter the securities fraud landscape.  Here are a few thoughts on the issues at stake in the case and a cautious prediction about how the Court will rule.

Read the full piece here. 

The Securities and Exchange Commission (SEC) recently scored a significant win against a Maryland banker accused of naked short-selling. What may be good news for the SEC is bad news for the market, as the SEC will now be more likely to persecute other alleged offenders of naked short-selling restrictions.

“Naked” short selling is when a trader sells stocks the trader doesn’t actually own (and doesn’t borrow in a prescribed period of time) in the hopes of buying the stocks later (before they must be delivered) at a lower price. The trader is basically betting that the stock price will decline. If it doesn’t, the trader must purchase the stock at a higher price–or breach their original sale contract.Some critics argue that such short-selling leads to market distortions and potential market manipulation, and some even pointed to short-selling as a boogey-man in the 2008 financial crisis, hence the restrictions on short-selling giving rise to the SEC’s enforcement proceedings.

Just one problem, there’s a lot of evidence that shows restrictions on short-selling make markets less efficient, not more.

This isn’t exactly news. Thom argued against short-selling restrictions seven years ago (here) and our late colleague, Larry Ribstein, followed up a couple years ago (here).  The empirical evidence just continues to pile in. Beber and Pagano, in the Journal of Finance earlier this year examine not just US restrictions on short-selling, but global restrictions. Their abstract reads:

Most regulators around the world reacted to the 2007–09 crisis by imposing bans on short selling. These were imposed and lifted at different dates in different countries, often targeted different sets of stocks, and featured varying degrees of stringency. We exploit this variation in short-sales regimes to identify their effects on liquidity, price discovery, and stock prices. Using panel and matching techniques, we find that bans (i) were detrimental for liquidity, especially for stocks with small capitalization and no listed options; (ii) slowed price discovery, especially in bear markets, and (iii) failed to support prices, except possibly for U.S. financial stocks.

So while the SEC may celebrate their prosecution victory, investors may have reason to be less enthusiastic.

Filed under: financial regulation, securities regulation, Sykuta

TOTM friend Stephen Bainbridge is editing a new book on insider trading.  He kindly invited me to contribute a chapter, which I’ve now posted to SSRN (download here).  In the chapter, I consider whether a disclosure-based approach might be the best way to regulate insider trading.

As law and economics scholars have long recognized, informed stock trading may create both harms and benefits to society.  With respect to harms, defenders of insider trading restrictions have maintained that informed stock trading is “unfair” to uninformed traders and causes social welfare losses by (1) encouraging deliberate mismanagement or disclosure delays aimed at generating trading profits; (2) infringing corporations’ informational property rights, thereby discouraging the production of valuable information; and (3) reducing trading efficiency by increasing the “bid-ask” spread demanded by stock specialists, who systematically lose on trades with insiders.

Proponents of insider trading liberalization have downplayed these harms.  With respect to the fairness argument, they contend that insider trading cannot be “unfair” to investors who know in advance that it might occur and nonetheless choose to trade.  And the purported efficiency losses occasioned by insider trading, liberalization proponents say, are overblown.  There is little actual evidence that insider trading reduces liquidity by discouraging individuals from investing in the stock market, and it might actually increase such liquidity by providing benefits to investors in equities.  With respect to the claim that insider trading creates incentives for delayed disclosures and value-reducing management decisions, advocates of deregulation claim that such mismanagement is unlikely for several reasons.  First, managers face reputational constraints that will discourage such misbehavior.  In addition, managers, who generally work in teams, cannot engage in value-destroying mismanagement without persuading their colleagues to go along with the strategy, which implies that any particular employee’s ability to engage in mismanagement will be constrained by her colleagues’ attempts to maximize firm value or to gain personally by exposing proposed mismanagement.  With respect to the property rights concern, deregulation proponents contend that, even if material nonpublic information is worthy of property protection, the property right need not be a non-transferable interest granted to the corporation; efficiency considerations may call for the right to be transferable and/or initially allocated to a different party (e.g., to insiders).  Finally, legalization proponents observe that there is little empirical evidence to support the concern that insider trading increases bid-ask spreads.

Turning to their affirmative case, proponents of insider trading legalization (beginning with Geoff’s dad, Henry Manne) have primarily emphasized two potential benefits of the practice.  First, they observe that insider trading increases stock market efficiency (i.e., the degree to which stock prices reflect true value), which in turn facilitates efficient resource allocation among capital providers and enhances managerial decision-making by reducing agency costs resulting from overvalued equity.  In addition, the right to engage in insider trading may constitute an efficient form of managerial compensation.

Not surprisingly, proponents of insider trading restrictions have taken issue with both of these purported benefits. With respect to the argument that insider trading leads to more efficient securities prices, ban proponents retort that trading by insiders conveys information only to the extent it is revealed, and even then the message it conveys is “noisy” or ambiguous, given that insiders may trade for a variety of reasons, many of which are unrelated to their possession of inside information.  Defenders of restrictions further maintain that insider trading is an inefficient, clumsy, and possibly perverse compensation mechanism.

The one thing that is clear in all this is that insider trading is a “mixed bag”  Sometimes such trading threatens to harm social welfare, as in SEC v. Texas Gulf Sulphur, where informed trading threatened to prevent a corporation from usurping a valuable opportunity.  But sometimes such trading creates net social benefits, as in Dirks v. SEC, where the trading revealed massive corporate fraud.

As regular TOTM readers will know, optimal regulation of “mixed bag” business practices (which are all over the place in the antitrust world) requires consideration of the costs of underdeterring “bad” conduct and of overdeterring “good” conduct.  Collectively, these constitute a rule’s “error costs.”  Policy makers should also consider the cost of administering the rule at issue; as they increase the complexity of the rule to reduce error costs, they may unwittingly drive up “decision costs” for adjudicators and business planners.  The goal of the policy maker addressing a mixed bag practice, then, should be to craft a rule that minimizes the sum of error and decision costs.

Adjudged under that criterion, the currently prevailing “fraud-based” rules on insider trading fail.  They are difficult to administer, and they occasion significant error cost by deterring many instances of socially desirable insider trading.  The more restrictive “equality of information-based” approach apparently favored by regulators fares even worse.  A contractarian, laissez-faire approach favored by many law and economics scholars would represent an improvement over the status quo, but that approach, too, may be suboptimal, for it does nothing to bolster the benefits or reduce the harms associated with insider trading.

My new book chapter proposes a disclosure-based approach that would help reduce the sum of error and decision costs resulting from insider trading and its regulation.  Under the proposed approach, authorized informed trading would be permitted as long as the trader first disclosed to a centralized, searchable database her insider status, the fact that she was trading on the basis of material, nonpublic in­formation, and the nature of her trade.  Such an approach would (1) enhance the market efficiency benefits of insider trading by facilitating “trade decod­ing,” while (2) reducing potential costs stemming from deliberate misman­agement, disclosure delays, and infringement of informational property rights.  By “accentuating the positive” and “eliminating the negative” conse­quences of informed trading, the proposed approach would perform better than the legal status quo and the leading proposed regulatory alternatives at minimizing the sum of error and decision costs resulting from insider trading restrictions.

Please download the paper and send me any thoughts.

Filed under: 10b-5, corporate law, disclosure regulation, error costs, financial regulation, insider trading, markets, regulation, securities regulation, SSRN

In light of yesterday’s abysmal jobs report, yesterday’s Wall Street Journal op-ed by Stanford economist John B. Taylor (Rules for America’s Road to Recovery) is a must-read.  Taylor begins by identifying what he believes is the key hindrance to economic recovery in the U.S.:

In my view, unpredictable economic policy—massive fiscal “stimulus” and ballooning debt, the Federal Reserve’s quantitative easing with multiyear near-zero interest rates, and regulatory uncertainty due to Obamacare and the Dodd-Frank financial reforms—is the main cause of persistent high unemployment and our feeble recovery from the recession.

A reform strategy built on more predictable, rules-based fiscal, monetary and regulatory policies will help restore economic prosperity.

Taylor goes on (as have I) to exhort policy makers to study F.A. Hayek, who emphasized the importance of clear rules in a free society.  Hayek explained:

Stripped of all technicalities, [the Rule of Law] means that government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances and to plan one’s individual affairs on the basis of this knowledge.

Taylor observes that “[r]ules-based policies make the economy work better by providing a predictable policy framework within which consumers and businesses make decisions.”  But that’s not all: “they also protect freedom.”  Thus, “Hayek understood that a rules-based system has a dual purpose—freedom and prosperity.”

We are in a period of unprecedented regulatory uncertainty.  Consider Dodd-Frank.  That statute calls for 398 rulemakings by federal agencies.  Law firm Davis Polk reports that as of June 1, 2012, 221 rulemaking deadlines have expired.  Of those 221 passed deadlines, 73 (33%) have been met with finalized rules, and 148 (67%) have been missed.  The uncertainty, it seems, is far from over.

Taylor’s Hayek-inspired counsel mirrors that offered by President Reagan’s economic team at the beginning of his presidency, a time of economic malaise similar to that we’re currently experiencing.  In a 1980 memo reprinted in last weekend’s Wall Street Journal, Reagan’s advisers offered the following advice:

…The need for a long-term point of view is essential to allow for the time, the coherence, and the predictability so necessary for success. This long-term view is as important for day-to-day problem solving as for the making of large policy decisions. Most decisions in government are made in the process of responding to problems of the moment. The danger is that this daily fire fighting can lead the policy-maker farther and farther from his goals. A clear sense of guiding strategy makes it possible to move in the desired direction in the unending process of contending with issues of the day. Many failures of government can be traced to an attempt to solve problems piecemeal. The resulting patchwork of ad hoc solutions often makes such fundamental goals as military strength, price stability, and economic growth more difficult to achieve. …

Consistency in policy is critical to effectiveness. Individuals and business enterprises plan on a long-range basis. They need to have an environment in which they can conduct their affairs with confidence. …

With these fundamentals in place, the American people will respond. As the conviction grows that the policies will be sustained in a consistent manner over an extended period, the response will quicken.

If you haven’t done so, read both pieces (Taylor’s op-ed and the Reagan memo) in their entirety.

Filed under: economics, financial regulation, Hayek, politics, regulation

New York Times columnist Gretchen Morgenson is arguing for a “pre-clearance”  approach to regulating new financial products:

The Food and Drug Administration vets new drugs before they reach the market. But imagine if there were a Wall Street version of the F.D.A. — an agency that examined new financial instruments and ensured that they were safe and benefited society, not just bankers.  How different our economy might look today, given the damage done by complex instruments during the financial crisis.

The idea Morgenson is advocating was set forth by law professor Eric Posner (one of my former profs) and economist E. Glen Weyl in this paper.  According to Morgenson,

[Posner and Weyl] contend that new instruments should be approved by a “financial products agency” that would test them for social utility. Ideally, products deemed too costly to society over all — those that serve only to increase speculation, for example — would be rejected, the two professors say.

While I have not yet read the paper, I have some concerns about the proposal, at least as described by Morgenson.

First, there’s the knowledge problem.  Even if we assume that agents of a new “Financial Products Administration” (FPA) would be completely “other-regarding” (altruistic) in performing their duties, how are they to know whether a proposed financial instrument is, on balance, beneficial or detrimental to society?  Morgenson suggests that “financial instruments could be judged by whether they help people hedge risks — which is generally beneficial — or whether they simply allow gambling, which can be costly.”  But it’s certainly not the case that speculative (“gambling”) investments produce no social value.  They generate a tremendous amount of information because they reflect the expectations of hundreds, thousands, or millions of investors who are placing bets with their own money.  Even the much-maligned credit default swaps, instruments Morgenson and the paper authors suggest “have added little to society,” provide a great deal of information about the creditworthiness of insureds.  How is a regulator in the FPA to know whether the benefits a particular financial instrument creates justify its risks? 

When regulators have engaged in merits review of investment instruments — something the federal securities laws generally eschew — they’ve often screwed up.  State securities regulators in Massachusetts, for example, once banned sales of Apple’s IPO shares, claiming that the stock was priced too high.  Oops.

In addition to the knowledge problem, the proposed FPA would be subject to the same institutional maladies as its model, the FDA.  The fact is, individuals do not cease to be rational, self-interest maximizers when they step into the public arena.  Like their counterparts in the FDA, FPA officials will take into account the personal consequences of their decisions to grant or withhold approvals of new products.  They will know that if they approve a financial product that injures some investors, they’ll likely be blamed in the press, hauled before Congress, etc.  By contrast, if they withhold approval of a financial product that would be, on balance, socially beneficial, their improvident decision will attract little attention.  In short, they will share with their counterparts in the FDA a bias toward disapproval of novel products.

In highlighting these two concerns, I’m emphasizing a point I’ve made repeatedly on TOTM:  A defect in private ordering is not a sufficient condition for a regulatory fix.  One must always ask whether the proposed regulatory regime will actually leave the world a better place.  As the Austrians taught us, we can’t assume the regulators will have the information (and information-processing abilities) required to improve upon private ordering.  As Public Choice theorists taught us, we can’t assume that even perfectly informed (but still self-interested) regulators will make socially optimal decisions.  In light of Austrian and Public Choice insights, the Posner & Weyl proposal — at least as described by Morgenson — strikes me as problematic.  [An additional concern is that the proposed pre-clearance regime might just send financial activity offshore.  To their credit, the authors acknowledge and address that concern.]

Filed under: economics, financial regulation, Hayek, Knowledge Problem, law and economics, regulation

The Federal Trade Commission conference announcement is below; note that public comments on the date of the conference.  This is an important space and should attract some excellent speakers.  The topics suggest a greater focus on consumer protection than competition issues.  Here is the announcement:

The Federal Trade Commission will host a workshop on April 26, 2012, to examine the use of mobile payments in the marketplace and how this emerging technology impacts consumers. This event will bring together consumer advocates, industry representatives, government regulators, technologists, and academics to examine a wide range of issues, including the technology and business models used in mobile payments, the consumer protection issues raised, and the experiences of other nations where mobile payments are more common. The workshop will be free and open to the public.

Topics may include:

• What different technologies are used to make mobile payments and how are the technologies funded (e.g., credit card, debit card, phone bill, prepaid card, gift card, etc.)?
• Which technologies are being used currently in the United States, and which are likely to be used in the future?
• What are the risks of financial losses related to mobile payments as compared to other forms of payment? What recourse do consumers have if they receive fraudulent, unauthorized, and inaccurate charges? Do consumers understand these risks? Do consumers receive disclosures about these risks and any legal protections they might have?
• When a consumer uses a mobile payment service, what information is collected, by whom, and for what purpose? Are these data collection practices disclosed to consumers? Is the data protected?
• How have mobile payment technologies been implemented in other countries, and with what success? What, if any, consumer protection issues have they faced, and how have they dealt with them?
• What steps should government and industry members take to protect consumers who use mobile payment services?

To aid in preparation for the workshop, FTC staff welcomes comments from the public, including original research, surveys and academic papers. Electronic comments can be made at https://ftcpublic.commentworks.com/ftc/mobilepayments. Paper comments should be mailed or delivered to: 600 Pennsylvania Avenue N.W., Room H-113 (Annex B), Washington, DC 20580.

The workshop is free and open to the public; it will be held at the FTC’s Satellite Building Conference Center, 601 New Jersey Avenue, N.W., Washington, D.C.

Filed under: antitrust, economics, financial regulation, technology, wireless