Academic journal article NBER Reporter

Economic Analysis of Law

Academic journal article NBER Reporter

Economic Analysis of Law

Article excerpt

My general interest is in using economics to analyze the effects of legal rules and institutions. In this article, I describe my current and recent work in the economics of four areas in which legal rules and institutions play a major role: corporate control and structure, bankruptcy, contracts, and litigation and settlement.

Corporate Control and Structure

While much of my earlier work in corporate control focused on takeover bids for companies with dispersed shareholders, my more recent research has focused on companies in which there is a controlling shareholder. In many public companies - both in the United States and (even more so) in other countries - a significant number of shares are concentrated in the hands of a controlling shareholder.(1)

One part of my research has focused on the decisions of controllers about selling their control blocks. In a recent article, I have shown that such decisions often might be distorted.(2) The efficiency costs produced by these distortions should be regarded as arising from having a controlling shareholder structure.

A central feature of the model of control transfers that I have developed is that controllers may differ from each other in two respects: their ability to manage and produce value; and their ability to capture private benefits of control. My analysis shows that, under the existing regime in the United States, inefficient transfers may take place; this will happen when the potential new controller has less managerial ability but a sufficiently greater ability to capture private benefits than the previous controller. Also under the existing regime, some efficient transfers may not take place; this will happen if the potential new controller, although better able to manage the company, has a sufficiently lower ability to capture private benefits.

My analysis also examined control transfers under the equal opportunity rule that prevails in many other countries. Under this rule, minority shareholders are entitled to participate in the transaction on the same terms as the control seller. My analysis shows that adopting the equal opportunity rule would prevent all inefficient transfers, but also would prevent a wider range of efficient transfers. Finally, the analysis has identified conditions under which adding the equal opportunity rule would and would not be efficient overall; for example, adopting the equal opportunity rule would produce an efficiency loss overall if existing and new controllers draw their characteristics from the same distributions.

In a related paper, Jesse Fried and I study the decisions of controllers on whether to effect a freezeout.(3) In a corporate freezeout, which is allowed under U.S. rules, a controller can take the shares of the minority shareholders and provide them instead with consideration exceeding the value of those shares as appraised by the court. Our model shows that decisions on whether to effect a freezeout may be distorted, thus producing another efficiency cost arising from having a controlling shareholder structure. The analysis identifies conditions under which efficient freezeouts might not take place or inefficient freezeouts might take place. We use this model to analyze how alternative legal rules perform with respect to the objectives of facilitating efficient freezeouts and discouraging inefficient ones.

These two projects take as given the existence of control blocks. Another part of my research examines the factors that determine the initial ownership structure. In joint work, Luigi Zingales and I(4) analyze the choice that initial owners make between retaining a complete ownership structure and creating a controlling shareholder structure by selling some shares to the public. We show that, in this choice, private and social optimality might diverge.

The source of this potential divergence is an externality. The initial choice of ownership structure will have important effects on both the initial shareholders and the potential future buyers of control. …

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