Banking and Finance Law Commons^™

Information Gaps And Shadow Banking, Kathryn Judge

Faculty Scholarship

This Article argues that information gaps – pockets of information that are pertinent and knowable but not currently known – are a byproduct of shadow banking and a meaningful source of systemic risk. It lays the foundation for this claim by juxtaposing the regulatory regime governing the shadow banking system with the incentives of the market participants who populate that system. Like banks, shadow banks rely heavily on short-term debt claims designed to obviate the need for the holder to engage in any meaningful information gathering or analysis. The securities laws that prevail in the capital markets, however, both presume …

Principal Costs: A New Theory For Corporate Law And Governance, Zohar Goshen, Richard Squire

Faculty Scholarship

The problem of managerial agency costs dominates debates in corporate law. Many leading scholars advocate reforms that would reduce agency costs by forcing firms to allocate more control to shareholders. Such proposals disregard the costs that shareholders avoid by delegating control to managers and voluntarily restricting their own control rights. This Essay introduces principal-cost theory, which posits that each firm’s optimal governance structure minimizes the sum of principal costs, produced when investors exercise control, and agent costs, produced when managers exercise control. Both principal costs and agent costs can arise from honest mistakes (which generate competence costs) and …

From Territorial To Monetary Sovereignty, Katharina Pistor

Faculty Scholarship

State sovereignty is closely intertwined with, but not limited to, control over territory and people. It has long been recognized that control over monetary affairs is a critical part of genuine sovereignty. In this Article, I go a step further and argue that the relevance and importance of territorial versus monetary sovereignty has shifted in favor of the latter. This shift goes hand in hand with the rise of credit-based financial systems. Such systems depend, in the last instance, on backstopping by an entity with control over its own money supply and no binding survival constraints. Only states with monetary …

Beyond Options, Edward R. Morrison, Anthony J. Casey

Faculty Scholarship

Scholars and policymakers now debate reforms that would prevent a bankruptcy filing from being a moment that forces valuation of the firm, crystallization of claims against it, and elimination of junior stakeholders’ interest in future appreciation in firm value. These reforms have many names, ranging from Relative Priority to Redemption Option Value. Much of the debate centers on the extent to which reform would protect the non-bankruptcy options of junior stakeholders, or harm the non-bankruptcy options of senior lenders. We argue that this focus on options misplaced. Protecting options is neither necessary nor sufficient for advancing the goal of a …

When Extrinsic Incentives Displace Intrinsic Motivation: Designing Legal Carrots And Sticks To Confront The Challenge Of Motivational Crowding-Out, Kristen Underhill

Faculty Scholarship

The rise of “nudges” has inspired countless efforts to encourage individual choices that maximize personal and collective welfare, with a preference for less restrictive tools such as setting default options or reordering choice sets. As part of this trend, there has been renewed interest in the behavioral impacts of incentives – namely, rewards or penalties for shaping individual choices, including but not limited to financial incentives. Explicit incentives are pervasive in the law, including carrots offered by governments (for example, tax deductions for charitable contributions, rebates for recycling, sentence reductions for prisoners who complete drug rehabilitation programs, and incentives for …

The Wolf At The Door: The Impact Of Hedge Fund Activism On Corporate Governance, John C. Coffee Jr., Darius Palia

Faculty Scholarship

Hedge fund activism has recently spiked, almost hyperbolically. No one disputes this, and most view it as a significant change. But, their reasons differ. Some see activist hedge funds as the natural champions of dispersed and diversified shareholders, who are less capable of collective action in their own interest. A key fact about activist hedge funds is that they are undiversified and typically hold significant stakes in the companies that comprise their portfolios. Given their larger stakes and focused holdings, they are less subject to the “rational apathy” that characterizes more diversified and even indexed investors, such as pension and …

Preserving The Corporate Superego In A Time Of Activism: An Essay On Ethics And Economics, John C. Coffee Jr.

Faculty Scholarship

This essay focuses on the impact of recent changes in corporate governance on ethical behavior within the public corporation. It argues that a style of corporate behavior – one characterized by a risk tolerant, even reckless, pursuit of short-term profits and a disregard for the interests of non-shareholder constituencies – is attributable in significant part to recent changes in corporate governance, including the rise of hedge fund activism, greater use of incentive compensation, and the appearance of blockholder directors. It then surveys feasible responses intended to strengthen the role of the boards as the corporation’s conscience and superego. Given the …

Is There Really A Sex Bureaucracy?, Suzanne B. Goldberg

Faculty Scholarship

This essay identifies several features of the higher-education context that can enrich The Sex Bureaucracy‘s account of why colleges and universities have adopted new policies and trainings to address sexual assault on their campuses. These features include: 1) schools’ preexisting systems for addressing student conduct; 2) the shared interest of schools in reducing impediments to education, including nonconsensual sexual contact; and 3) the pedagogical challenges of developing trainings that are engaging and effective. Taking these three factors into account, we can see that while federal Title IX intervention has had a profound effect, it is also important not to …

Corporate Control And Idiosyncratic Vision, Zohar Goshen, Assaf Hamdani

Faculty Scholarship

This Article offers a novel theory of corporate control. It does so by shedding new light on corporate-ownership structures and challenging the prevailing model of controlling shareholders as essentially opportunistic actors who seek to reap private benefits at the expense of minority shareholders. Our core claim is that entrepreneurs value corporate control because it allows them to pursue their vision (i.e., any business strategy that the entrepreneur genuinely believes will produce an above-market rate of return) in the manner they see fit. We call the subjective value an entrepreneur attaches to her vision the entrepreneur’s idiosyncratic vision. Our framework identifies …

Economic Crisis And The Integration Of Law And Finance: The Impact Of Volatility Spikes, Edward G. Fox, Merritt B. Fox, Ronald J. Gilson

Faculty Scholarship

The 2008 financial crisis raised puzzles important for understanding how the capital market prices common stocks and in turn, for the intersection between law and finance. During the crisis, there was a dramatic fivefold spike, across all industries, in "idiosyncratic risk" – the volatility of individual-firm share prices after adjustment for movements in the market as a whole.

This phenomenon is not limited to the most recent financial crisis.This Article uses an empirical review to show that a dramatic spike in idiosyncratic risk has occurred with every major downturn from the 1920s through the recent financial crisis. It canvasses three …

The First Year: The Role Of A Modern Lender Of Last Resort, Kathryn Judge

Faculty Scholarship

Insufficient liquidity can trigger fire sales and wreak havoc on a financial system. To address these challenges, the Federal Reserve (the Fed) and other central banks have long had the authority to provide financial institutions liquidity when market-based sources run dry. Yet, liquidity injections sometimes fail to quell market dysfunction. When liquidity shortages persist, they are often symptoms of deeper problems plaguing the financial system.

This Essay shows that continually pumping new liquidity into a financial system in the midst of a persistent liquidity shortage may increase the fragility of the system and, on its own, is unlikely to resolve …

Short-Termism And Long-Termism, Michal Barzuza, Eric L. Talley

Faculty Scholarship

A significant debate in corporate law and finance concerns the role of activist investors (especially hedge funds) in corporate governance. Activists, it is often alleged, imprudently privilege short term earnings over superior (but less liquid) long term investments. Activists counter that they target managers who unjustifiably cling to questionable strategies. While this debate is hardly new, it has grown increasingly fractious of late. We analyze the activism debate within a theoretical securities-market setting. In our framework – which draws from an emerging literature in empirical and experimental finance – managers are differentially overconfident (causing them to favor long-term projects), while …

A Tale Of Two Kadis: Kadi Ii, Kadi V. Geithner & U.S. Counterterrorism Finance Efforts, Douglas Cantwell

National Security Law Program

The European Court of Justice's final decision in Kadi II-Yassin Abdullah Kadi's challenge in Europe to his designation as an international terrorist financier has stimulated significant discussion on the relationship between European and international law. Less attention has been paid to the Kadi II's correlate in US. courts, Kadi v. Geithner, decided in the D.C. Circuit. The varying outcomes in these cases create a "transnational split record" that has implications for reform of multilateral counterterrorism sanctions.

This Note considers the impact of Kadi's legal challenges in the United States and Europe from the perspective of U.S. counterterrorism policy. …

The New Stock Market: Sense And Nonsense, Merritt B. Fox, Lawrence R. Glosten, Gabriel Rauterberg

Faculty Scholarship

How stocks are traded in the United States has been totally transformed. Gone are the dealers on NASDAQ and the specialists at the NYSE. Instead, a company’s stock can now be traded on up to sixty competing venues where a computer matches incoming orders. High-frequency traders (HFTs) post the majority of quotes and are the preponderant source of liquidity in the new market.

Many practices associated with the new stock market are highly controversial, as illustrated by the public furor following the publication of Michael Lewis’s book Flash Boys. Critics say that HFTs use their speed in discovering changes in …

Equity's Unstated Domain: The Role Of Equity In Shaping Copyright Law, Shyamkrishna Balganesh, Gideon Parchomovsky

Faculty Scholarship

As used today, the term “equity” connotes a variety of related, but nonetheless distinct, ideas. In most contexts, equity refers to the body of rules and doctrines that emerged in parallel with the common law, and which merged with the common law by the late nineteenth century. At a purely conceptual level, some trace the term back to Aristotle’s notion of epieikeia, or the process of infusing the law with sufficient flexibility to avoid injustice. Lastly, at a largely practical level, a few treat equity as synonymous with a set of remedies that courts can authorize, all of which …

Rules Of Thumb For Intercreditor Agreements, Edward R. Morrison

Faculty Scholarship

Intercreditor agreements frequently restrict the extent to which subordinated creditors can participate in the bankruptcy process by, for example, contesting liens of senior lenders, objecting to a cash collateral motion, or even exercising the right to vote on a plan of reorganization. Because intercreditor agreements can reorder the bargaining environment in bankruptcy, some judges have been unsure about their enforceability. Other judges have not hesitated to enforce the agreements, at least when they do not restrict the voting rights of subordinated creditors. This essay argues that intercreditor agreements are controversial because they pose a trade-off: they reduce bargaining costs (by …

Mandatory Disclosure And Individual Investors: Evidence From The Jobs Act, Colleen Honisberg, Robert J. Jackson Jr., Yu-Ting Forester Wong

Faculty Scholarship

One prominent justification for the mandatory disclosure rules that define modem securities law is that these rules encourage individual investors to participate in stock markets. Mandatory disclosure, the theory goes, gives individual investors access to information that puts them on a more equal playing field with sophisticated institutional shareholders. Although this reasoning has long been cited by regulators and commentators as a basis for mandating disclosure, recent work has questioned its validity. In particular, recent studies contend that individual investors are overwhelmed by the amount of information required to be disclosed under current law, and thus they cannot and do …

Intermediary Influence, Kathryn Judge

Faculty Scholarship

Ronald Coase and others writing in his wake typically assume that institutional arrangements evolve to minimize transaction costs. This Article draws attention to a powerful, market-based force that operates contrary to that core assumption: Intermediary influence." The claim builds on three observations: (1) many transaction costs now take the form of fees paid to specialized intermediaries, (2) intermediaries prefer institutional arrangements that yield higher transaction fees, and (3) intermediaries are often well positioned to promote self-serving arrangements. As a result, high-fee institutional arrangements often remain entrenched even in the presence of more-efficient alternatives.

This Article uses numerous case studies from …

Bank Resolution In The European Banking Union: A Transatlantic Perspective On What It Would Take, Jeffrey N. Gordon, Wolf-Georg Ringe

Faculty Scholarship

The project of creating a Banking Union is designed to overcome the fatal link between sovereigns and their banks in the Eurozone. As part of this project, political agreement for a common supervision framework and a common resolution scheme has been reached with difficulty. However, the resolution framework is weak, underfunded and exhibits some serious flaws. Further, Member States' disagreements appear to rule out a federalized deposit insurance scheme, commonly regarded as the necessary third pillar of a successful Banking Union. This paper argues for an organizational and capital structure substitute for these two shortcomings that can minimize the systemic …

Through The Looking Glass To A Shared Reflection: The Evolving Relationship Between Administrative Law And Financial Regulation, Gillian E. Metzger

Faculty Scholarship

Administrative law and financial regulation have an uneasy relationship today. It was not always so. Indeed, the two were closely intertwined at the nation's birth. The Treasury Department was a major hub of early federal administration, with Alexander Hamilton crafting the first iterations of federal administrative law in his oversight of revenue generation and customs collection. One hundred and fifty years later, administrative law and financial regulation were conjoined in the New Deal's creation of the modern administrative state. This time it was James Landis, Chair of the newly formed Securities and Exchange Commission (SEC) and author of the leading …

The Future Of Direct Finance: The Diverging Paths Of Peer-To-Peer Lending And Kickstarter, Kathryn Judge

Faculty Scholarship

For centuries, the trend has been toward longer and more complex intermediation chains in a wide array of contexts. The growing length and complexity of intermediation chains were both the by-products and drivers of ever-greater globalization and specialization. In recent years, however, there has been a shift in the opposite direction. In a variety of markets, suppliers and consumers increasingly transact directly with one another. Many of these developments have arisen from technological innovations that reduce search costs and other hurdles to transacting, like verifying information and negotiating the terms of a transaction. Airbnb, Etsy, and their kin, for example, …

Three Proposals For Regulating The Distribution Of Home Equity, Ian Ayres, Joshua Mitts

Faculty Scholarship

The Consumer Financial Protection Bureau’s recently-released “qualified mortgage” rules effectively discourage predatory lending but miss an equally important source of systemic risk: low-equity clustering. Specific “volatility-inducing” mortgage terms, when present in a substantial cluster of mortgage contracts, exacerbate macroeconomic risk by increasing the chance that the housing and lending markets will have to absorb a wave of simultaneous defaults after a downturn in housing prices. This Article shows that these terms became prevalent in a substantial proportion of residential mortgages in the years leading up to the home mortgage crisis. In contrast, during the earlier “amortization era” (when mortgagors were …

The Judiciary And Fiscal Crises: An Institutional Critique, Peter Conti-Brown, Ronald J. Gilson

Faculty Scholarship

Scholars have long debated the role for courts with respect to governmental action that responds to crisis. Most of the crises analyzed, however, are exogenous to the political process; the courts’ role in response to politically endogenous crises has received less attention. We evaluate the role of the judiciary in a subset of those endogenous crises: the judicial treatment of governmental efforts to resolve the crisis facing underfunded public pensions. Assessing institutional competence schematically with reference to an institution’s democratic accountability and fact-finding ability, we argue that, where institutions function properly, judicial intervention in politically endogenous economic crises should be …

Do Defaults On Payday Loans Matter?, Ronald J. Mann

Faculty Scholarship

This essay examines the effect on a borrower’s financial health of failure to repay a payday loan. Recent regulatory initiatives suggest an inclination to add an “ability to pay” requirement to payday-loan underwriting that would be fundamentally inconsistent with the nature of the product. Because the premise of that regulation would be that borrowers suffer harm when they fail to repay such a loan, it is timely to examine the after-effects of such a default empirically. This essay examines that question using a dataset that combines payday borrowing histories with credit bureau information.

The essay uses a difference-in-difference approach, comparing …

Managing The Public Trust: How To Make Natural Resource Funds Work For Citizens, Andrew Bauer, Perrine Toledano, Malan Rietveld

Columbia Center on Sustainable Investment Staff Publications

Given their collective size – approximately $3.5 trillion in assets as of end-2013 and growing – and concerns about the motivations of their government owners, much has been written on natural resource funds (NRFs), their investments and global influence. However their impacts on governance and public financial accountability at home have received far less attention.

On the one hand, these funds can be used to serve the public interest, for example by covering budget deficits when resource revenues decline, saving for future generations, or helping to mitigate Dutch Disease through fiscal sterilization. On the other hand, they can undermine public …

The Empty Call For Benefit-Cost Analysis In Financial Regulation, Jeffrey N. Gordon

Faculty Scholarship

The call for benefit-cost analysis (BCA) in financial regulation misunderstands the origins and utility of BCA as a guide to administrative rule making. Benefit-cost analysis imagines an omniscient social planner who can calculate costs and benefits from a natural system that generates prices (costs and benefits) that do not change (or change much) no matter what the central planner does. For example, the toxicity of chemicals, the health hazards of emissions, the statistical value of life – these do not change in response to health-and-safety regulation. For the financial sector, however, the system that generates costs and benefits is constructed …

Dodd-Frank Orderly Liquidation Authority: Too Big For The Constitution?, Thomas W. Merrill, Margaret L. Merrill

Faculty Scholarship

Title II of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 establishes a new specialized insolvency regime, known as orderly liquidation, for systemically significant nonbank financial companies. While well intended, Title II unfortunately raises a number of serious constitutional questions. To vest authority in an Article III judge to appoint a receiver for such companies, yet also avoid a financial panic, Dodd–Frank requires that the judicial proceedings be conducted in secret, with no notice to the public or other interested parties on pain of criminal penalties, and that the judge rule on the petition to appoint the …

On Experimentation And Real Options In Financial Regulation, Matthew L. Spitzer, Eric L. Talley

Faculty Scholarship

Financial regulators have recently faced enhanced judicial scrutiny of their cost-benefit analysis (CBA) in advance of significant reforms. One facet of this scrutiny is judicial skepticism toward experimentation (and the real option to abandon) in the CBA calculus. That is, agencies have arguably been discouraged from counting as a benefit the value of information obtained through adopting new regulations on a provisional basis, with an option to revert to the status quo in the future. We study field experimentation versus more conventional forms of CBA (or analytic learning) in a regulatory-judicial hierarchical model. We demonstrate that there is no principled …

How To Improve The Financial Architecture And Its Resilience, Dirk Helbing, Eve Mitleton-Kelly, Jean-Philippe Bouchaud, Fabio Caccioli, J. Doyne Farmer, Steve Keen, Katharina Pistor, Dennis J. Snower, Olsen Richard, Angelo Ranaldo, Norbert Häring, Edward Fullbrook

Faculty Scholarship

This financial resilience survey was circulated on behalf of a working group of the Complexity Council of the World Economic Forum comprised of Prof. Eve Mitleton-Kelly of London School of Economics and Prof. Dirk Helbing at ETH Zurich's Risk Center. It was sent to a few dozens of financial experts with the aim to create an inventory of ideas of how the financial system might be improved and made more resilient. Unconventional ideas were also welcome.

Money Market Funds Run Risk: Will Floating Net Asset Value Fix The Problem?, Jeffrey N. Gordon, Christopher M. Gandia

Faculty Scholarship

The instability of money market mutual funds (“MMF”), a relatively new form of financial intermediary that connects short-term debt issuers with funders who want daily liquidity, became manifest in the financial crisis of 2007-2009. The bankruptcy of Lehman Brothers, a major issuer of money market debt, led one large fund to “break the buck” (that is, violate the $1 net asset valuation convention (“NAV”)) and triggered a run on other funds that was staunched only by major interventions from the U.S. Treasury and the Federal Reserve. One common reform proposal has been to substitute “floating NAV” for “fixed NAV,” on …