I had never heard of Intrade before.  Maybe I live in a hole.

Let’s see here:  I’d love to short the bid for Dec. 07 if it wasn’t at zero.  No way I’d touch the 10 ask.  I think there’s over a 90% chance this goes into next year.  The bid/ask spread is so big for Mar. 08 and Jun. 08 (40/60 and 60/80, respectively) as to make them unattractive too.  However, if my hand were forced, I’d short the bid of 40 for Mar. 08.  I guess another way of framing that is to say I’m more likely to believe there’s at least a 60% chance this extends past Mar. 08 as opposed to the other “break even” alternatives of a 60% chance it doesn’t, a 40% chance it extends past Jun. 08, or an 80% chance it doesn’t.  This is all assuming a “buy and hold” strategy.

My actual strategy is…………………no purchase…………………..secret answer C.

I recently came across a keynote speech by Frank Easterbrook (published at 52 Emory L.J. 1297 (2003)) where he discusses Type I errors in antitrust cases.  Easterbrook, of course, produced the fundamental insight for antitrust enforcement that competition itself constrained the costs associated with false negatives while false positives were likely to ripple throughout the economy.  The argument is frequently raised that those concerned with false positives overestimate both their frequency and impact.  Sometimes this argument is coupled with the challenge: if Type I errors are so important, show me one in the cases!   In Easterbrook’s speech, he makes the point that the error rates do not have to be very high to produce serious consequences:

Courts are not supposed to go along with suits by or in the interest of rivals, but error is endemic in the judicial system. Let us suppose that there is a ten percent chance of a Type I error–that is, wrongful condemnation of an efficient practice–in any given antitrust  case. If ten cases can be brought in different jurisdictions, and they are resolved independently, then the risk of wrongful condemnation in at least one case climbs to sixty-five percent (0.910 = 0.349). Because any federal judge can issue a nationwide injunction, a single false positive can obliterate the challenged practice. And if the risk of a Type I error is fifteen percent, then the aggregate error rate in ten suits is eighty-one percent–which is to say that efficient, pro-consumer practices are highly likely to be suppressed. These numbers should cause great discomfort–and some large firms, of which Microsoft is only one example, are facing more than ten independent suits about the same practices. Maybe judges do better than this example gives them credit for: if the rate of Type I errors is five percent, then ten suits produce “only” a forty percent risk of wrongful condemnation. Sorry, but I’m still worried. Not until the error rate gets down to the one percent range in any given area does my concern abate–and I must tell you that the judges I know err more often than that. I do too.

As an aside, the challenge to produce examples of false positives from litigated cases misses the point of the social costs of false positives.  The real social costs associated with false positives are not just the treble damages and all of the follow-on private litigation in the litigated cases — though those certainly count too.  The larger social costs are the pro-competitive conduct that never occurs in the first place for fear of antitrust liability.

This potentially anticompetitive bundling alert comes courtesy of Lynne Kiesling at the always wonderful Knowledge Problem.  Kiesling observes that the Chicago foie gras ban has resulted in restaurants bundling salad with foie gras. I take it that the bundle circumvents the ban. Apparently, this means that consumers who want their foie gras are now coerced into eating salad! They are at least forced to purchase the salad. Surely, this is an attempt to monopolize the salad market. I feel an antitrust class action coming on. While their at it, the class might want to take a look at these onerous “no substitution” rules some restaurants impose for various specialty dishes rather than offering a full a la carte menu allowing consumers unfettered choice among all the possible combinations and permutations of ingredients. A serious analysis of these problems is well beyond the scope of this post.   But I do advise Chicago restauranteurs to seek antitrust counsel.

RELATED POST: See Thom’s earlier entry on What’s the Matter With Chicago?

A few days ago, I posted a comment about Starbucks’ recent disclosure that its average per store traffic has gone down slightly even though overall profits have gone up. I suggested a number of explanations for these phenomena consistent with a story that consumer taste for the Starbucks product has not diminished. One of these explanations was that Starbucks makes its product available to non-Starbucks retailers and that consumers may be turning increasingly to these other retailers. That is, consumers could be shifting away from Starbucks stores rather than away from the Starbucks product. In passing, I observed that Starbucks’ distribution of its product to non-Starbucks stores is proconsumer and belies the accusations of some opportunistic competitors who claim that Starbucks’ business model is anticompetitive.

Yesterday, Stephen Bainbridge helpfully pointed out that Starbucks owns its stores and does not franchise them (correcting my reference to Starbucks “franchisees”). At the same time, Stephen also notes that Starbucks does license holders of otherwise inaccessible real estate to sell Starbucks products, an arrangement that is economically indistinguishable from franchising. I appreciate this clarification from Stephen. But I also should say that the analysis and conclusions in my original post do not turn on the distinction between Starbucks owning or franchising its stores. The important point is that the Starbucks product is available at other places besides Starbucks stores, such as at Barnes & Noble. Whether these alternatives are created by franchise or license is immaterial. Stephen does not dispute my conclusion that the antitrust allegations against Starbucks are without merit. And though he presents the point as “a problem with [my] analysis,” Stephen’s correction is, as Josh explains, really factual rather than analytical.

Leaving aside the issue of why traffic is down at Starbucks stores, Stephen raises (or rather recycles from a superb earlier posting he wrote back in 2003) the important question of why some firms like Starbucks choose to own their own stores (i.e., to vertically integrate) while other firms such as Subway choose to franchise. Many great minds have weighed in on this question over the years, beginning (at least implicitly) with Ronald Coase’s great 1937 essay “The Nature of the Firm” (which uses variation in transaction costs to explain a firm’s choice between internal and external contracting) and continuing most recently with Josh’s and Larry Ribstein’s excellent postings in response to Stephen.

I wish to add here only one point to the analysis. Whatever its economic benefits, vertical integration has the added virtue that it can reduce a firm’s exposure to certain types of antitrust claims. While a franchisor and franchisee can be sued under Section 1 of the Sherman Act for anticompetitive vertical restraints (such as vertical price fixing or other forms of restricted distribution such as territorial restraints), a single firm or a parent and its wholly owned subsidiaries are immune from such suits under the Supreme Court’s Copperweld decision, which held that a firm cannot conspire with itself for purposes of satisfying the conspiracy element of Section 1. At the same time, even while reducing exposure under Section 1, vertical integration by a firm with an already high market share can increase the firm’s exposure to a monopolization (or attempted monopolization) claim under Section 2.

The antitrust factor may well be one explanatory variable in Starbucks’ decision to own its stores rather than franchise them and Subway’s decision to franchise rather than own. Starbucks has a high and growing market share in the market for retail coffee, particularly if one defines the product market narrowly to include only “high end” coffee. It is plausible that a court could find it to have some degree of “market power” (though not “monopoly power”) in this market, which makes it vulnerable to Section 1 claims with respect to its arms’ length, vertical arrangements. Owning its own stores reduces that exposure, and since the stores have been owned from the start rather than acquired later there isn’t an apparent act of monopolization that would increase the firm’s exposure under Section 2. Subway, by contrast, seems much less dominant in its product space and indeed may not even have “market power” at all. If that is right, then Subway would benefit from vertical integration much less than Starbucks does–at least from an antitrust perspective.

Needless to say, other factors may well be at work besides the antitrust factor, as Josh, Larry, and Stephen ably suggest. My point here is only to add antitrust as another variable that may well explain firm franchising behavior in some range of cases.

Professor Bainbridge offers a correction to Keith’s Starbucks analysis by pointing out that Starbucks does not have franchisees. I don’t think the franchise/ franchisee distinction has much to do with Keith’s conclusion that whatever is going on is not an antitrust problem. But the Professor is on to a really cool question about franchising and vertical integration. Professor Bainbridge presents the contrasting franchising decisions by Starbucks and Subway as a transactions cost puzzle and links to a fuller analysis of this problem here:

What bugs me about the Subway v. Starbucks problem is that I can’t see any reason to believe that Subway’s transaction cost schedule is going to differ from that of Starbucks.

Bainbridge continues with the conventional account of the economics of franchising, focusing primarily on monitoring costs:

Franchising gives a residual claimant-like status to the local franchisee, while the franchise contract gives the franchisee incentives to ensure that the local employees comply with brand requirements. Franchising thus can be understood as an adaptive response to the problem of monitoring numerous employees in countless locations.

If this analysis is correct, one would expect to see corporate ownership in settings where monitoring via a vertically integrated management structure can be effected at low cost (relative to situations in which franchising dominates). But does Starbucks really face lower monitoring costs than Subway? If not, did Starbucks make an economic error by not going the franchise route?

The comments to Professor Bainbridge’s prior analysis from the folks at Marginal Revolution (and others) following the post hint at cross-store cannibalization as the key to the economic explanation. This is basically right, or at least, on the right track. But I think all this talk about “monitoring” and “transactions costs” is covering up some really interesting economics that shed some light on vertical contracting more generally. Don’t get me wrong, the critical variable that should influence the vertical integration decision here is indeed (as Professor Bainbridge says) the monitoring costs of franchisor owned outlets relative to franchised oulets. But I think these rather vague labels are blurring some important underlying economics.

So what’s going on with Starbucks’ decision to vertically integrate its outlets? I offer some analysis below the fold.

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Paul asks about the Vegas odds on XM/ Sirius merger approval.  Its not quite Vegas, but Intrade is offering contracts on merger approval on or before December 2007, March 2008, and June 2008.  They’re trading at 5, 50, and 70 respectively.   So Paul, any of those contracts look good to you?

The countdown is on for the XM-Sirius merger decision! (I wouldn’t be optimistic that the “end of the year” decision target will stand.)  Former FCC Chairman Reed Hundt and Representative Rich Boucher (D-Va) have recently come out in favor of the merger.  As everyone knows, it’s all about market definition, baby!  I’m not a gambling man, but I’d love to know what the Vegas odds would be for approval.

http://www.broadcastingcable.com/article/CA6500514.html?rssid=193

http://www.businessweek.com/technology/content/nov2007/tc20071115_361525.htm?chan=search

George Washington University Law School Professor Larry Mitchell’s new book, The Speculation Economy, is a worthwhile read, and anyone with an interest in corporate law, securities regulation, stock market evolution, the rise of big business, legal history, antitrust, and other related topics should consider putting the book on his or her holiday wish-list. 

More specifically, The Speculation Economy is a valuable book for anyone wanting to understand how the legal, regulatory, financial, and legislative climate of big business evolved through the late 1800s into the early 1900s, laying the foundation for today’s modern publicly-held corporations and giving rise to what Mitchell calls “American corporate capitalism.”  Though the time period covered in the book is narrow, the developments during this period are far-reaching and important.  To that end, Mitchell fearlessly deconstructs the antitrust, corporate law, securities law, and the related federalism and state competition events over these three decades, describing, blow-by-blow, the move from a large business entity world dominated by major individual players focused on building an industrial enterprise to a business environment where business entities – trusts turned conglomerates turned corporations – were no longer a means to an end but rather an end in and of themselves. 

And Mitchell’s attention to detail is actually where I found the true value in the book.  Based on the book’s subtitle – “How Finance Triumphed Over Industry” – and based on various reviewers’ comments on the jacket and otherwise, I thought the book would be valuable because it explains why finance came to dominate industry.  The reality, however, is that the book basically dispenses with that issue in its first two chapters.  The rest of the book is spent on an a journey through the regulatory, legislative, state, political, and federal struggling and machinating in response to this capital market paradigm shift.  It is this rich discussion and description that I found most valuable and wonderfully edifying.  Mitchell takes us from New Jersey’s appearance as the first winner of the real race to the bottom to the Panic of 1907 to early attempts to federalize corporate law to the Owen Bill, the Pujo Committee, the Hepburn Act, the Mann-Elkins Act, and the Littlefield Bill to the sunset of Woodrow Wilson’s economic progressivism (covering, on the way, a whole host of other relevant material).  The Speculation Economy is a solid historical read highlighting a critical time in corporate and capitalism history. 

Columbia Professor Harvey Goldschmid’s comment on The Speculation Economy book jacket promises that “[a]nyone interested in the development of our modern financial markets will be richly rewarded by a careful reading.”  Harvey was right.  The Speculation Economy, while requiring an attentive, slower read due to its factual density, delivered, in return, a wealth of information, coherently explained and colorfully detailed, about a pivotal time in corporate history.  The book earned its rightful place on my office bookshelf of corporate and securities law tomes, and, for only 279 pages of text (excluding the endnotes), The Speculation Economy is must-read contribution to the legal history, corporate law, securities regulation, and big business scholarship.

** Look for the Conglomerate’s book review session on The Speculation Economy in a few weeks!    http://www.theconglomerate.org/conglomerate_book_club/index.html

Traffic at Starbucks shops open for 13 months or more is down one percent. Does this mean that the public is finally losing its appetite for Starbucks? Not necessarily.

While traffic is down, profits are up. Thus a more likely explanation for the new data is the firm’s price increase last summer rather than a change in consumer tastes. Another possibility is that even if demand *per store* is down, overall demand could still be constant or even up, given that Starbucks is always opening new stores whose sales to some extent dilute the revenues of existing stores. A third factor that may explain things, and this is the one that I want to focus on because it is of interest to antitrust lawyers, is that Starbucks stores do not enjoy exclusivity in the sale of Starbucks coffee.

You can go into a Barnes & Noble and other non-Starbucks stores and find a cafe selling “Starbucks coffee” even though the seller isn’t a Starbucks. The coffee itself and the surrounding atmosphere at such cafes (complete with their wireless hotspots to go with the lowfat lattes) are in many cases close to perfect substitutes for Starbucks stores. Sales at such places, if they are increasing at an ever faster rate, may well be diluting sales at Starbucks stores and hence may well account for the new data.

Starbucks’ willingness to sell its product widely rather than reserve it exclusively for its full-service franchisees suggests to me that the firm is competing aggressively in an “output enhancing,” pro-consumer way, rather than seeking to find ways to reduce output and raise price, as some opportunistic antitrust plaintiffs have erroneously alleged.

All therefore seems well for the Starbucks franchise–even if, as Jackie Mason has quipped, it is a bit much to ask customers both to clean up after themselves and also to leave a tip!

U of Chicago Law Professors Douglas Baird and M. Todd Henderson (my very smart, very tall law school classmate) recently posted a provocative paper on SSRN. The paper, Other People’s Money, contends that “the oft-repeated maxim that directors of a corporation owe a fiduciary duty to the shareholders” is an “almost-right principle that has distorted much of the thinking about corporate law in recent decades.” Baird and Henderson argue that we should scrap this “almost-right” but mischief-causing principle in favor of a principle that would ground duties to all investors in contract.

Given innovations in corporate finance, the lines among shareholders, debtholders, and creditors have become quite blurred. Accordingly, Baird and Henderson argue, “[i]dentifying only shareholders as investors, as opposed to all providers of capital, is misleading.” Moreover, giving common stockholders the most privileged spot in the pecking order, as the notion of fiduciary duties owed to shareholders seems to do, may be inappropriate. How, for example, could the directors of a distressed corporation ever file for bankruptcy, thereby harming shareholders at the expense of creditors? Baird and Henderson argue that theorists committed to “the sacred cow that the duty of the directors is owed solely to the shareholders” have “paint[ed] themselves into embarrassing corners” trying to address the filing of a bankruptcy petition and other situations where shareholder interests seem appropriately subordinate to those of other capital providers.

If we are to jettison the notion that fiduciary duties are owed to shareholders, what principle should replace it? The most obvious candidate, Baird and Henderson observe, would be a rule that “directors must adopt the course that, in their judgment, maximizes the value of the firm as a whole.” (And a strong business judgment rule would apply to directors’ decisions.) Under this approach, which resembles the approach Judge Easterbrook took in In re Central Ice Cream Co., 836 F.2d 1068 (7th Cir. 1987), “claims by one class of investor against another alleging breach of fiduciary duty would fail so long as the directors acted reasonably to enhance firm value.”

But Baird and Henderson maintain that this “maximize the value of the enterprise” approach is also deficient. In particular, it fails to account for common situations in which senior investors, such as venture capitalists who own preferred stock with voting rights, bargain for the right to “pull the plug” on a venture — even though doing so would leave common stockholders with nothing and wouldn’t maximize the value of the firm ex post. Such arrangements, Baird and Henderson argue, may be value-maximizing ex ante because they give managers (generally junior claimants) an incentive to manage well. But, of course, the provisions can’t have this value-enhancing effect if they can’t be enforced due to a fiduciary duty running to common stockholders. Baird and Henderson thus argue that courts shouldn’t “stand in the way” of this “contracting regularity.” Instead, courts should honor contracts among directors and capital providers — even those that would disadvantage common stockholders.

In all, a terrific paper. It’s consistent with my view (explained in detail here) that the contracts between corporate constituents should be freely tailorable by the parties, and with my argument (set forth in the last part of this paper) that fiduciary duties should not preclude corporations from authorizing certain forms of insider trading.

My only quibble with the paper is that it seems to suggest in a couple of places that we should junk altogether the notion of fiduciary duties owed to shareholders. (See, e.g., page 8: “Hence, it may make sense to eliminate the concept of fiduciary duty from corporate law altogether.”) I wouldn’t go that far. Fiduciary duties running to shareholders exist because the cost of drafting contracts that would expressly state the constraints on managers’ conduct is simply too great. Because managers and shareholders can’t envision all the various contingencies that will arise, decide up front how those issues should be resolved, and memorialize those decisions in an express contract, the law polices manager conduct by positing amorphous duties of diligence and loyalty — duties whose precise content is fleshed out ex post. As Easterbrook and Fischel put it, “The only promise that makes sense in such an open-ended relation [as that between managers and shareholders] is to work hard and honestly.” The fact is, we need fiduciary duties running to shareholders to act as contractual gap fillers; we shouldn’t jettison them altogether.

That said, we should recognize that fiduciary duties owed to shareholders are nothing more than contractual gap-fillers. That is, they are contract terms that exist absent some provision to the contrary. Thus, to quote Easterbrook and Fischel again, “Because the fiduciary principle is a rule for completing incomplete bargains in a contractual structure, it makes little sense to say that ‘fiduciary duties’ trump actual contracts.”

If fiduciary duties are so construed, the concern that animates Baird and Hnderson becomes easy to remedy. Suppose a corporate charter were to include some provision stating that fiduciary duties to shareholders shall not be violated by executing or performing contracts with other capital providers as long as those contracts were in the best interests of the firm, measured from the perspective of the ex ante bargain among investors. The fiduciary duties owed shareholders — important contractual terms in the bargain between shareholders and managers — would still exist but wouldn’t be violated by actions authorized by contracts with other capital providers. This, I think, is a better outcome than scrapping altogether the notion of fiduciary duties running to shareholders.

Despite some language that might suggest otherwise, I believe this is the outcome Baird and Henderson are ultimately advocating. The penultimate paragraph of the paper suggests as much:

Board decisions should follow control rights, wherever and in whatever form they are manifest, and courts should largely get out of the way. This means courts should refuse to give creditors fiduciary duties (say in the zone of insolvency), refuse to allow shareholders to use fiduciary duties as a mechanism for upsetting director decisions that increase firm value or are conceivably part of the investors’ ex ante bargain, and refuse to perpetuate the inefficient link between disclosure and fidicuary duties. Directors should take from court decisions the simple maxim that they should do what is in the best interest of the firm, measured from the perspective of the ex ante bargain among investors. This will mean maximizing the firm value in nearly every case, but…sometimes acting in ways that seem selfish but are really just efficient and, when viewed ex ante, value-maximizing.

Yet another major airline merger appears to be in the works: United and Delta. This calls for some antitrust analysis. A few months ago, Thom did a thorough job analyzing the antitrust aspects of AirTran’s proposed takeover of Midwest. The key point in Thom’s analysis was that assessment of an airline merger’s economic effects properly centers not on the merging parties’ overall market shares but rather on the extent to which the two firms compete head-to-head.

United and Delta are large carriers, the second and third largest in the industry. If one uses overall industry market shares to calculate HHI in the merger analysis, the transaction would seem presumptively unlawful. But if one looks at the actual routes on which the two airlines compete and the level of competition currently present on those routes from other carriers, the picture may look very different. If it is the case that the two firms now compete head-to-head only (or largely) on routes that are are served by a large number of carriers, then the firms’ high overall market shares may not matter very much.

That said, a note of caution. In a major airline asset acquisition some years ago, American/TWA, the firms argued that the transaction should be permitted on the ground that TWA (then in bankruptcy) was a “failing firm” and that therefore the transaction’s effect on HHI was not dispositive. The enforcement authorities (wrongly) bought into this argument and permitted the transaction, even though TWA’s airplanes would not have “left the industry” (the relevant standard under a failing firm theory) if they had been sold to the second highest bidder rather than to American. Commercial airplanes are a long term, durable capital good that can’t easily be converted into other uses. Sure TWA’s creditors wanted to maximize the value of TWA’s assets. But that’s not a reason to relax the requirements of antitrust law any more than it would be to permit a bankruptcy debtor to violate the Clean Water Act.

As with TWA, neither United’s nor Delta’s planes will disappear from the market if the deal is blocked, nothwithstanding the firms’ recent bankruptcies and the financial woes that chronically plague the industry. The United/Delta deal should be assessed solely on the basis of its competitive effects. The failing firm argument has no place here, and the parties should not assume that the enforcement authorities will treat them as generously as they treated American and TWA.

The Glom book club takes a look at Frank Partnoy’s “FIASCO” ten years later here and here.

The debate over the whether the current Supreme Court’s decisions are more accurately described as influenced by the Chicago School, the Harvard School, Post-Chicago thinking, or other influences has recently attracted a great deal of scholarship from premier antitrust scholars (e.g. FTC Commissioner William Kovacic’s article on the identifies a Chicago/Harvard double-helix structure in the intellectual foundations of antitrust law, Commissioner Rosch finds Chicago’s fingerprints on the recent SCOTUS decisions but reserves hope that this influence is diminishing in the lower courts, and Herbert Hovenkamp’s (Iowa) paper arguing that dominant firm antitrust jurisprudence reveals the prominent influence of the Harvard School).

The debate has continued as the Roberts Court has had the opportunity to make its mark on antitrust jurisprudence with its high level of activity in this area of law. The latest installment of this debate as found its home at Competition Policy International where Einer Elhauge (Harvard Law) and I chime in on the recent Roberts Court antitrust activity. Elhauge’s article concludes that the Roberts Court decisions represent the influence of the Harvard School rather than Chicagoan influence. I take the diametrically opposed and apparently contrarian view that the Roberts Court antitrust jurisprudence has incorporated the lessons of the Chicago School in my own contribution to this literature in the same issue of Competition Policy International, The Roberts Court and the Chicago School of Antitrust: The 2006 Term and Beyond (also available on SSRN). Here’s the abstract:

The U.S. Supreme Court issued four antitrust decisions this Term (the most it has issued since the 1989-1990 Term) and seven cases over the past two years. The antitrust activity level of the Roberts Court thus far has exceeded the single case average of the Court prior to the 2003-2004 Term by a significant margin. What can be said of the Roberts Court’s antitrust jurisprudence? This article examines the quartet of Supreme Court decisions issued during the 2006-2007 Term in an attempt to identify and characterize the antitrust philosophy of the Roberts Court. I argue that the Roberts Court decisions embrace the Chicago School of antitrust analysis and predict that the antitrust jurisprudence of this Court will increasingly reflect this influence.

The side by side publication of these articles should make for an interesting comparison of two very different perspectives on the recent cases and where the Court may be going. Go read them both.

I should also mention that the issue of Competition Policy International, along with some other great content including a symposium on Antitrust in Asia, includes an insightful analysis of Supreme Court decisions from 1967-2007 from Judge Douglas H. Ginsburg (along with Leah Brannon). Brannon and Ginsburg identify a number of trends in these decisions, including increased deference to recommendations by the Solicitor General, more consensus, and more economic reasoning. You can access the entire CPI issue here.

For those interested in small company finance, I’ve recently posted on SSRN a draft of the short piece I’ve written for the Entrepreneurial Business Law Journal symposium issue. The piece is entitled “The Truth About Reverse Mergers” and can be downloaded here. Here’s the abstract:

The Article examines the reverse merger method of going public. It describes the principal features of reverse mergers, including deal structure and legal compliance. Although reverse mergers are routinely pitched as cheaper and quicker than traditional IPOs, the Article argues that such pitches are misleading and, for many companies, irrelevant.