On Friday, January 22, I attended the Fifth Annual Henry G. Manne Law & Economics Conference, which was sponsored by the Law & Economics Center at George Mason University. The Conference was held in conjunction with the Twelfth Annual Symposium of the Journal of Law, Economics, & Policy, a publication of the GMU School of Law. This year’s Conference was entitled, “The Enduring Legacy of Henry G. Manne,” and featured three panels of academic experts, all of whose research draws substantially on the work of the late Henry Manne. Manne was the long time Dean of the Law School, and a trailblazing scholar of corporate governance and corporate finance.
Regrettably, owing to inclement weather, the day’s program had to be truncated, including dropping the scheduled Key Note luncheon speech by former Securities and Exchange Commission commissioner, Kathleen Casey. Even under the shortened time frame, however, the panel discussions were thorough and highly informative.
The first panel focused on Manne’s seminal 1965 Journal of Political Economy article, “Mergers and the Market for Corporate Control.” Speakers included GMU business professor, Bernard Sharfman, and University of Chicago Law professor, Todd Henderson.
In the JPE article, Manne developed the then-novel insight that when a corporation is afflicted with inefficiencies owing to poor management, an incentive is created for others to take control of the corporation, eliminate the managerial inefficiencies, and be rewarded with an increase in share price. What this means is that there is a functioning market for corporate control.
Drawing on this insight, Professor Sharfman considered whether activist investors might be able to perform the same function, specifically activist hedge funds. One key difference between activist investors and take-over investors is that the former typically are not able to obtain a controlling interest in a corporation. Although the interest can be significant, it falls short of the authority to dictate managerial changes. Therefore, when activist investors see managerial inefficiencies, they must rely principally on persuasion to influence corrective action.
Corporate boards, however, often, if not most of the time, resist this activism. In some instances, the boards might go so far as to sue in court for relief. When this occurs, the courts are bound by the “business judgment rule,” which provides for deference to the decisions of corporate boards. Sharfman contends that, although the business judgement rule is based on solid grounds and usually works well as a legal rule, it fails under the circumstances just described, i.e., when there are managerial inefficiencies but activist investors are unable to obtain a controlling interest in the company. Sharfman concludes, therefore, that it might be time for the courts to carve out, albeit carefully, an exception to the business judgment rule in cases where the evidence points to no plausible business reason to reject the activists’ position. In this circumstance, a court can find that the board’s resistance likely owes to no more than an attempt to protect an entrenched management.
Building on Manne’s insight of the existence of a “market” for corporate control, Professor Henderson considered the possibility of such diverse hypothetical markets as (1) markets for corporate board services, (2) markets for paternalism and altruism, and (3) markets for trust. In the first instance, Henderson posited the possibility that shareholders simply contract out board services rather than having a board solely dedicated to one company. So, for example, persons with requisite expertise could organize into select board-size groups and compete with other such groups to offer board services to the shareholders of any number of separate corporations.
In the second instance, Henderson, noting the growing modern viewpoint that companies have paternalistic obligations toward stakeholders that go beyond shareholder interests, suggested that the emergence of a competitive market to meet such obligations would likely be superior to relying on evolving government mandates. Competitive markets, for example, would avoid delivering “one size fits all” services and, in so doing, be better able to delineate beneficiary groups on the basis of their specific needs, i.e., needs common within a group but diverse across groups. Inefficient cross-subsidization could thus be mitigated. In this same vein, Henderson suggested the possibility of a market for the delivery of altruistic services. He noted that the public is increasingly demanding that corporations, governments, and non-profits engage in activities deemed to be socially desirable. As with the provision of paternalism, competitively supplied altruism whereby companies, governments, and non-profits comprise the incumbent players would yield the positive attributes of competition. These would include the emergence of alternative mixes of altruistic services tailored to the specific needs of beneficiaries and efficient, low cost production and delivery of those services.
In the third instance, Henderson posited the idea of a market for trust. Here he offered the example of the ride-sharing company, Uber. Henderson suggested that Uber not only competes with traditional taxis, but, perhaps more importantly, competes with local taxi commissions. Taxi commissions exist to assure the riding public that it will be safe when hiring a taxi. Toward that end, taxis are typically required to have a picture of the driver and an identifying number on display, be in a well maintained condition, and have certain other safety features. All of these things are intended to generate a level of trust that a ride will be safe and uneventful. According to Henderson, Uber’s challenge is to secure a similar level of trust among its potential customers. New companies shaking up other traditional service industries face the same challenge. Henderson concludes, therefore, that these situations open up entrepreneurial opportunities to supply “trust.” Although Henderson did not use the example of UL certification, that analogy came to mind. So, for example, there might be a private UL-type entity in the business of certifying that ride sharing (or any other new service company) is trustworthy.
In commenting on Panel 1, Bruce Kobayashi, a GMU law professor and former Justice Department antitrust economist, offered one of the more interesting observations of the day. Professor Kobayashi reminded the audience that Manne’s concern in his JPE article was principally directed at antitrust enforcement, not corporate law. In particular, Manne argued that the elimination of managerial inefficiency should rightly be counted as a favorable factor in an antitrust analysis of a merger. In fact, however, although the DOJ/FTC Horizontal Merger Guidelines allow for cognizable, merger-specific efficiencies to be incorporated into the analysis of net competitive effects, the agencies historically only consider production and distribution cost savings, not the likelihood of gains to be had from jettisoning bad management. Kobayashi suggested that this gap in the analysis may be due simply to the compartmentalization of economists among individual specialties. For example, in his experience, he rarely sees industrial organization (antitrust) economists interacting professionally with economists who study corporate governance. Thus, because Manne’s article, through the years, has come to be classified (incorrectly) as solely a corporate law article, its insights have unjustifiably escaped the attention of antitrust enforcers.
Panel 2 focused on Henry Manne’s seminal insights about “insider trading.” Manne was the first to observe that, notwithstanding the instinctive negative reaction of many, if not most, people to insider trading (“It’s just not right!”), the practice actually has beneficial effects in terms of economic efficiency. By more quickly incorporating new information about a business’s prospects into share price, insider trading can accelerate the movement of that price toward a market clearing level, which signals a truer value of a company and thus enhances allocative efficiency in capital flows.
The two principal speakers on Panel 2 were Kenneth Rosen, a law professor at the University of Alabama and John Anderson, a professor at the Mississippi College School of Law. I will limit my comments to Anderson.
In addition to being a lawyer, Professor Anderson is a philosopher by training, holding a Ph.D. in that subject. He began his presentation by noting that ethical claims are often vague in a way that economic analysis, given its focus on efficiency, is not. Although in any empirical study, there can be problems with finding good data and there can be measurement difficulties, the analytical framework of economics rests on an objective standard. Either a given behavior increases efficiency, reduces efficiency, or is benign toward efficiency. Anderson also observed that ethics merely sets goals, while economic analysis determines the best (i.e., most efficient) means to achieve those goals.
Putting these distinctions into the context of insider trading, Anderson finds that insider trading laws and enforcement of those laws are likely overreaching. The current statutory scheme rests largely on ethical notions, namely the issue of unfairness (“It’s just not right!”). As such, it rests on vague standards. The result is a loss of economic efficiency and costly over-compliance with the laws. In the end, not only are shareholders hurt (e.g., by costly compliance and litigation), but the larger investing public is also harmed owing to slower price adjustments. Anderson made the point that, although acts of greed may be bad for individual character, such acts are not necessarily bad for the entire community.
In concluding his presentation, Anderson proposed that some form of licensing of insider trading might best accommodate the competing ethical and efficiency goals. Under a licensing system, insider trading could be permissible in certain circumstances, but under full transparency.
Panel 3 considered the effects of required disclosures under federal security laws. The two principal speakers were Houman Shadab of New York Law School and Brian Mannix of George Washington University.
Despite being a novice in the subject matter of the day, I felt that I followed the discussions of the first two panels reasonably well. Panel 3, however, was difficult for me, as the speakers made frequent references to statutory provisions and SEC interpretations of relevant security law, with which I have no familiarity. Nonetheless, a portion of the discussion intrigued me.
In particular, Professor Mannix discussed the issue of high frequency trading (HFT), a hot topic just now because of Michael Lewis’s recent book, Flash Boys. As I understand it, computer technology makes it possible for trades to take place within microseconds. With evermore sophisticated algorithms, traders can attempt to beat each other to the punch and arbitrage gains even at incredibly small price differences.
Of particular interest to regulators is the likelihood of a tradeoff inherent in HFT that determines net efficiency effects. On the one hand, HFT has the potential to enhance efficiency by accelerating the movement of a share price to its equilibrium. Given that this movement is tiny and occurs within a microsecond, however, this efficiency gain may not be significant. Indeed, the efficiency gains, if any, are likely to be very slight.
On the other hand, a lot of costly effort goes into developing and deploying HFT algorithms. Yet, much of the payoff may be no more than a rearrangement of the way the arbitrage pie is sliced rather than any enlargement of the pie. If so, the costs incurred to win a larger slice of the pie, costs without attendant social wealth creation, likely exceed any efficiency gain. It may make sense then for regulators to create some impediments to HFT. Toward this end, Mannix offered some possible ways to make HFT less desirable to its practitioners. The most intriguing was to put into place technology that would randomly disrupt HFT trades. Key to profiting substantially from HFT is the need to trade in very large share volumes because the price differences over which the arbitrage takes place are so small. Random disruptions would make such big bets riskier.*
All in all, I found each of panels to be highly informative. The cast of speakers was well selected, and each presentation was well made. Significantly, each panel did a very good job of tying its discussion to Henry Manne’s work and influence. In addition to learning a great deal about current hot issues in corporate law and how economic analysis informs those issues, conference attendees surely left with an even higher appreciation of Henry Manne.
On the logistical front, in light of last minute adjustments necessitated by weather conditions, the organizers pulled off the conference flawlessly. A high standard was set that will be difficult for the organizers of next year’s offering to surpass.
Finally, on a personal note, Henry Manne was my law school Dean at GMU and also a neighbor for many years in my condominium. I remember Henry most, however, because of the dramatic impact that his unique curriculum at GMU had on my intellectual development. That curriculum, which emphasized the application of economic analysis to the law, literally changed the way I think about the world. For this reason, I was especially pleased that each of the speakers at the Conference took time to comment on the influence that Manne had on them. Some had never met Manne in person, but nonetheless were deeply influenced by his scholarly work. Others who knew Manne more intimately related some wonderful anecdotes. Those alone would have made the day worthwhile.
* For a further and more detailed explanation of the tradeoffs inherent in HFT, readers are encouraged to see a blog post by Todd Zywicki, the Executive Director of the LEC, which appeared here.
Theodore A. Gebhard is a law & economics consultant residing in Arlington, Virginia. See the Contributors page for more about Mr. Gebhard. Contact him at firstname.lastname@example.org. For more about Henry Manne, see the several tributes to him upon his passing on David Henderson’s blog, including one by Mr. Gebhard.