In my previous post, I sketched out some trends in the Law & Economics movement in recent years. Specifically, I’ve focused on the trends towards increasing mathematical formality and specialization within economics as a stand alone discipline. The post triggered some thoughtful responses from Larry Solum and Larry Ribstein for which I am grateful. I also received a number of responses in private which asked, rather bluntly, “So what?” The point was that even if everything I claimed about trends in economics and L&E were true, perhaps the result would be L&E scholars being more detached from the legal academy and migrating to economics departments. Again, so what? L&E work would be getting done by somebody somewhere. More than one of these private responses included the observation that maybe L&E types should be in economics departments anyway where there are tougher tenure standards, peer review, and less pay.

I planned on jumping in to the issue of where I think L&E in law schools is heading (including the issue of theory versus empirical work that David Zaring raised in the comments to the first post) and then what law schools and other institutions could do to solve the “problem.” But it seems like I might have more work to do to establish that the movement of L&E away from the legal academy would, indeed, be a real problem worth solving. So, in this post I’ll try to make the case that the trends highlighted in the first post, despite the benefits of mathematical rigor and precision, should give L&E scholars pause. The next three posts will get into the details of how I think this trend will play out in law schools, economics departments, and in legal scholarship itself.

My sense is that the increase in mathematical rigor poses special problems for L&E for several reasons. The primary reason is that the historical success of law and economics turns at least in part of its unparalleled success at the retail level. First and second generation producers of law and economics scholarship — think Director, Alchian, Coase, Williamson, Posner, Easterbrook, Calabresi, Stigler, Demsetz, and others — were able to “sell” important economic insights to lawyers, judges, policy audiences and the legal academy more broadly. Henry Manne took advantage of the power and accessibility of the economics insights from these L&E scholars by bringing them together at Economics Summer Camps to teach economics to law professors. The newly educated law professors would in turn, retail the power of economic thinking to law students. A similar process would take place with efforts to teach federal judges basic microeconomic theory through the George Mason Law and Economics Center programs which were also a brainchild of Henry Manne (this seems like a good place to plug Larry Ribstein’s essay on Henry Manne: Intellectual Entrepreneur which is forthcoming in a book I am co-editing with my colleague Lloyd Cohen on the Pioneers of Law and Economics).

In any event, the point is that much of the success of L&E owes to its success at the retail level. Antitrust is a wonderful example of the success of L&E. There is perhaps no other area where economic theory is integrated into the law. But even in areas where economics have not completely dominated the intellectual discourse, L&E has been an important voice in academic and policy debates in many areas of the law. Its voice is one that pushes for an understanding of how economic agents will respond to changes in the law, how markets work, and how markets respond to legal change. No matter whether one adopts the L&E worldview, as I do, I don’t think there is much debate the L&E has added a significant and valuable perspective to legal discourse. Indeed, one can make the case that its impact has been mores strongly felt than any other interdisciplinary approach to the law. The recent trend towards detachment from the retail audiences, from this perspective, is a special historical development in L&E. It is also one that is quite troublesome from the perspective of an L&E scholar who would like to see the field retain its influence. L&E scholarship, it seems, is at a crossroads. The concern is not just that L&E scholarship as we know it will move to economics departments. After all, economics departments do not currently value much of the work that is done by L&E scholars. The concern is that L&E scholarship as we know it will disappear altogether.

So far, I’ve unfairly painted a picture of formal methods in economics as ruining L&E without any upside. This may appear odd coming from somebody who does some modeling and econometrics in his own research. So let me make sure I’m being clear. Mathematical rigor and formality is not without its benefits. Modeling can help generate testable implications. Mathematics can force out into the daylight hidden assumptions and make explanations more precise in a unique way. Like any other tool in economic science, mathematical modeling can produce insights for some problems but maybe less so for others. It would neither make sense to claim that L&E left no room for the sort of detailed institutional analysis and exposition supplied by Alchian, Coase, Williamson, Klein, Demsetz, or Tullock than it would to claim that L&E should ignore the insights generated by careful theoretical or econometric work. Though I do quite a bit of econometric work in my own research, I do believe (perhaps to the chagrin of my econometrician friends) that there is still some important empirical work to be done in L&E that doesn’t necessary involve large scale datasets and statistical analysis.

Frequently, discussions of the increased formality of economics also include the observation that it has become pretty easy to run a regression with modern statistical software packages. This is also an important development in L&E scholarship and empirical legal scholarship more generally. I agree with others who have observed that the reduced costs to doing empirical work has become a problem in L&E scholarship in the legal academy. It is certainly true that legal scholars will make improper use of econometric tools from time to time. It is also true that misuse of empirical methods is less likely to be prevented by the peer review mechanism. Though on the positive side of the ledger, conferences like CELS are doing excellent work to raise the bar for empirical scholarship. Similarly, economists may fall prey to the mistake of letting the tools and methods determine which questions they answer, perhaps because the tools and methods determine what is publishable in top journals, or produce models or econometric work that is of little relevance. Neither of these errors are particularly interested to me, though I suspect the incidence of both errors has grown dramatically over time with the increasing demand for empirical legal scholarship and also changes in economic science over the past 30 years.

While I’ve focused on the costs of formalization and specialization throughout this and future posts, I do not want to be misunderstood as leveling the “physics envy” critique at economists, e.g. that economists use modeling as a thinly veiled attempt to make their work look more serious or to adopt a complex language to increase barriers to entry (an accusation most lawyers should be familiar with). For instance, a significant portion of my own research agenda involves some theoretical modeling and econometrics. As an aside, I’ve always thought that particular rhetorical critique (”physics envy”) was not very effective. Formalization clearly has both benefits and costs. The question I am interested in is how this change in economic science will change L&E as a discipline — its already started — and as we know it in law schools.

The increase in mathematical rigor in economics has translated, not surprisingly, into work in L&E that also makes increasing use of formal modeling or econometric methods. One consequence has been something I described as the “retail problem” in my last post:

L&E scholars will do work that is very relevant, and maybe even very good, but legal scholars wont know about it or care about it because of the “translation” issues associated with the formal mathematics will prevent it from being retailed to broader audiences, (the “retail” problem)

In other words, increased formalization has meant that a larger fraction of relevant and high quality L&E work has become less accessible to lawyers, judges, and policy makers. A simple way to describe this trend towards increased formalization might be as a movement toward of L&E towards the prevailing methods and trends in its home discipline. One might question whether this is a problem at all. For the reasons discussed above, I think it is. And at the very minimum, this trend has serious implications for the direction the L&E movement is headed in law schools and in legal scholarship.

The rest of this series, hopefully, will discuss various aspects of this problem. There are at least three immediate questions I think worth discussing concerning the implications of this trend of L&E generally:

(1) What will L&E scholarship in law schools look like in the future? This encompasses questions like whether informal L&E will be “crowded out” as the work becomes increasingly detached from, and presumably less valuable to, not only its intended audience but also colleagues in the law school. It also encompasses questions like whether “serious” L&E scholars will migrate towards economics departments leaving law schools behind. (Larry Solum raises this and other possible scenarios in a very thoughtful response to this post which also addresses how this trend might play out in the legal academy more generally).

(2) What efforts can be made to secure the benefits of specialization and formality while minimizing the likelihood of detachment from the traditional “legal” audience? This line of questioning presumes, I think correctly, that detachment would be a serious blow to the L&E movement and encompasses questions like: What role can law schools and other institutions play in ensuring that L&E remains interdisciplinary (not leaning too far toward its “home discipline”) and relevant?

(3) Does This Trend Have Implications for Law School Specialization? Larry Solum suggests that one possible path is the multidisciplinary model where graduate students would be trained in the basic methodologies of their discipline (the law) and PhD programs that trained in specialties such as empirical legal studies, economics, positive political theory, advanced doctrinal methods, etc. As law school specialization is a topic I’ve written about here previously (here, here and here), and a model that I’m familiar with here at George Mason, one might ask whether this trend toward formal L&E scholarship will impact schools like George Mason who have staked out a position as a school that specializes in L&E?

I plan on writing a separate post addressing each of these three questions over the next week or so.

I’m very interested in the history, the present, and the future of the law and economics methodology and movement. Recently, I’ve been giving some thought to the direction of the movement, especially as it currently exists in the legal academy. Some of my thinking has been inspired by this post from Larry Ribstein, the comments to this post at Prawfs (especially those from Brian Leiter and Kate Litvak), and Steven M. Teles’ book on the Rise of the Conservative Legal Movement, each of which highlights some of the trends and tensions emerging in the field as well as what has made it so successful. Much of the discussion in those blog posts has to do with whether a Ph.D. is necessary or sufficient to do modern L&E scholarship, or at least, whether there is room interdisciplinary scholarship for those without the PhD or equivalent technical skills. That all debate has been hammered out fairly thoroughly. My target in what I hope will be a series of posts is different, though not orthogonal to that debate: where is L&E now and where is it going?

There are a couple of general trends pushing on the law and economics movement from different directions that make speculation about the future of the movement interesting and raise a number of interesting questions. I don’t think I know the answers to these questions, but I thought it would be fun to write a series of blog posts that sketch out my tentative thinking on these general trends, identify some potential strengths and weaknesses of the L&E movement in its current form, share some thoughts about where it is headed, and hopefully stimulate some discussion.

In this first post, I’m going to try to set the stage by identifying some of the trends in the L&E movement in particular and their causes and consequences. In future posts, I’ll try to shed some light on where I think the L&E movement in law schools is going, where it isn’t going, and where I’d like it to go in the next 5-10 years. First, lets start by sketching the landscape with the identification and description of some general trends and patterns in L&E below fold.

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Harvard’s Einer Elhauge answers the titular question in the newest issue of Competition Policy International, in response to a review of his new textbook Global Antitrust Law and Economics (with Damien Geradin) at the newly revamped Global Competition Policy website.   The response essay is less about the particulars of the book than it is about what the fundamental goals of modern competition law courses are and should be.  The debate takes the form of teaching doctrine and procedure vs. economic analysis with Elhauge defending the latter.  Here’s an excerpt from Elhauge driving home the point:

I inserted the bolded portion.  This is a lesson I try to impart to my antitrust students and one that I hope that they take to heart by the time the semester is over.  I think Elhauge has this exactly right.  Check out the essay.

Speaking of Nudge, Cato is holding a  book forum on Cass Sunstein and Richard Thaler’s new book on May 1 which will feature Sunstein, and comments from Will Wilkinson and my colleague Terrence Chorvat.  Registration is free and you can also watch the event live at the link above.

I wrote this brief post awhile back, and forgot to post it on April 12th, Armen’s 94th birthday.  I’m late.  But better late then never they say.

On Armen Alchian’s 94th birthday, it seems appropriate to reflect on some of his contributions to economics and economic analysis of the law.  Armen has been described as “the Armenian Adam Smith,” and his name is frequently mentioned on the “short list” of Nobel candidates every year (at least it is on this blog).  Armen’s influence on economics and law and economics is difficult to overstate.  Armen’s classic paper with Harold Demsetz (AER, 1972) remains influential in the theory of the firm literature and is listed as the 12th most important paper in economics since 1970 by Kim et al.  Klein, Crawford and Alchian’s seminal analysis of vertical integration and the holdup problem (JLE, 1978) ranks #30 on this list.  Of course, though a sign of his significant intellectual contributions, citations to scholarly articles do not begin to measure the mark Armen left on the fields he touched.  More generally, and harder to measure, is Armen’s general influence on the economics of property rights and the development of what has been called the “UCLA School” of economics.

In addition to his scholarly contributions, Armen’s teaching style is the stuff of legend.  By the time I arrived in Westwood Armen was done teaching the graduate microeconomics class, so I missed out on that.  But I was lucky enough to have him on my dissertation committee at UCLA and experience some of Armen’s approach first hand.  Tales are abound of the careers of economists-in-the-making that Armen influenced in one way or another.  Nobel Laureate William F. Sharpe captures some of this in his autobiographical exposition explaining Alchian’s influence on his own career:

Armen Alchian, a professor of economics, was my role model at UCLA. He taught his students to question everything; to always begin an analysis with first principles; to concentrate on essential elements and abstract from secondary ones; and to play devil’s advocate with one’s own ideas. In his classes we were able to watch a first-rate mind work on a host of fascinating problems. I have attempted to emulate his approach to research ever since. When I returned to pursue the PhD degree, I took a field in microeconomics with Armen and he also served as chairman of my dissertation committee.

Any Alchian student or fan knows that Armen also had a heavy influence in the training of judges and lawyers through the George Mason Law and Economics Center Program started by Henry Manne.  In an important antitrust policy speech, former FTC Chairman Timothy Muris articulates a sentiment I’ve heard repeatedly from those who went through the program or watched Armen teach:

Armen Alchian was unexcelled in teaching economics to lawyers. He often presented economics socratically - a technique familiar to lawyers. For years Armen was one of the most popular instructors in Henry Manne’s programs for teaching economics to lawyers. In short courses, he taught literally hundreds of federal judges and law professors.

Of course, I suspect Armen’s socratic approach may have differed in style when delivered to graduate students rather than judges and lawyers.  In many ways, Armen is as much a founder of the law and economics movement, and deserving of credit for its spread, as the those traditionally credited with the origination of that movement: Coase, Manne, Becker, and Calabresi.

Here are some Alchian links for interested readers:

• A Biography  and another profile hosted at David Levine’s website
• Uncertainty and Economic Evolution: Essays in Honor of Armen A. Alchian (edited by John R. Lott, Jr.)
• A 2000 Liberty Fund interview by Daniel K. Benjamin in the Intellectual Portrait series
• Alchian’s collected works in two volumes
• Alchian’s “Property Rights” entry to the Concise Enyclopedia of Economics
• A profile of Alchian in the UCLA Daily Bruin in 2006
• My blog post making the case for a “UCLA School” Nobel Prize in honor of the contributions of Alchian, Demsetz & Klein

Happy 94th Birthday Armen.

• James Pethokoukis at US News reports on interviews with chief economic advisers Austan Goolsbee and Douglas Holtz-Eakin.
• Brian Leiter is pleased to point out a study showing that while both groups are in the top 3, Philosophy majors outperform Economics majors on the LSAT.  Leiter also gets in a playful dig, noting that the study “corresponds exactly to the natural intellectual hierarchy evident throughout the legal academy.” Ouch. Hmmm. We’ll see Brian’s study and raise him this one suggesting that economics, unlike some other high performing undergraduate majors, actually translates beyond LSAT performance into higher earnings.
• The Federal Trade Commission has announced its First Annual Microeconomics Conference
• Gary Becker on why the airlines are so bad
• Quantifying the Colbert Bump (HT: Tyler Cowen)

The D.C. Circuit’s opinion is available here.  Here is one of the key passages explaining the D.C. Circuit’s logic:

To the extent that the ruling (which simply reversed a grant of dismissal) rested on the argument that deceit lured the SSO away from non-proprietary technology, see id., it cannot help the Commission in view of its inability to find that Rambus’s behavior caused JEDEC’s choice; to the extent that it may have rested on a supposition that there is a cognizable violation of the Sherman Act when a lawful monopolist’s deceit has the effect of raising prices (without an effect on competitive structure), it conflicts with NYNEX.

More on this later.  My preliminary reaction is that the opinion contains some fairly broad-sweeping language that should make the patent holdup landscape fairly interesting in the near future, especially when contrasted to cases like Broadcom and N-Data.

Sunstein and Thaler have a series of posts over at Volokh Consipiracy on their new book Nudge, which expands on their notion of libertarian paternalism (see here, here , here and here).  Something in the most recent post caught my eye.  In preparing to respond to various objections to libertarian paternalism, Sunstein argues that this sort of paternalism offers the “best of both worlds”:

In short, we hope that libertarian paternalism might provide a real third way, one that recognizes the best in Hayek and Friedman while also noticing the work of Simon, Kahneman, and Tversky (and Thaler), which shows that human beings often choose poorly. Thus, for example, libertarian paternalism offers fresh ways of thinking about the mortgage crisis, credit card reform, savings for retirement, prescription drugs, health care, environmental law, and even marriage. In all these contexts, a few nudges could help a lot.

One of the problems that I have with libertarian paternalism marketed in this manner is that it sells traditional economic theory short by describing it as missing the point that individuals make errors.  Perfection is costly, and so the optimal rate of errors is not zero.  The argument against paternalism, libertarian or otherwise, is not that individuals  have perfect foresight and do not make errors (even systematic ones).  It is that individuals will tend to make better self-interested decisions than the government would do on their behalf. 

A second problem, and one I’ve noted before, is that:

In accounting for the long run costs of paternalism, we must also be mindful of dynamic effects that are likely to follow from paternalistic decision-making before intervening (on this last point, see Klick and Mitchell in the Minnesota L. Rev., or more recently Ed Glaeser’s essay on Paternalism and Psychology).

These long term dynamic costs of paternalistic intervention surely must be part of the cost-benefit analysis with respect to any such regulatory proposal.   In other words, there is a danger that my mitigating the costs of errors through regulation, we increase the rate of errors.  This point goes directly to the appropriateness of the “libertarian” modifier for this type of paternalism.  Sunstein & Thaler argue that liberty is maintained because these proposals encourage choice rather than coercive mandates.  But the libertarian case also rests on the presumption that allowing individuals to bear the costs of their errors leads to better and more competent choices in the future.  Many, but not all, of the proposed “nudges” do not appear to take this concern to seriously.

The new issue of the Journal of Law & Economics is available online. This is an exciting development for me because the issue includes my paper with Ben Klein on The Economics of Slotting Contracts (SSRN version available here), and because it has been a very long wait to see the paper in final form (note the new release is of the August 2007 issue of JLE). The primary contribution of the paper is to explain the incidence of shelf space contracts as a consequence of the normal competitive process and examine the conditions under which those contracts will take the form of a lump sum per-unit time payment rather than a wholesale price or volume discount. We also have provide some empirical evidence that is consistent with the time series and cross-sectional incidence of slotting across product categories (see also here).

Readers with an interest in antitrust might want to also check out the Duso, Neven & Roller event study analysis of EU merger decisions and Taylor’s analysis of NIRA cartel performance. And to be filed under the category of “law of unintended consequences,” Jonathan Klick and Thomas Strattman also have a very interesting empirical piece demonstrating that state mandates requiring coverage of diabetes treatments have resulted in offsetting behavioral changes and higher Body Mass Index after the mandates.

The Klein and Wright abstract is below the fold:

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Amit Gandhi, Luke Froeb, Steven Tschantz and Gregory Werden have published “Post-Merger Product Repositioning” in the Journal of Industrial Economics.  (HT: Luke).  The critical insight is that the conventional unilateral effect incentive to raise prices post-merger is offset by the incentive to “separate” in product space.  Here is the abstract:

This paper analyzes the effects of mergers between firms competing by simultaneously choosing price and location.  Products combined by a merger are repositioned in away from each other to reduce cannibalization, and non-merging substitutes are, in response, repositioned between the merged products.  This repositioning greatly reduces the merged firm’s incentive to raise prices and thus substantially mitigates the anticompetitive effects of the merger.  Computation of, and selection among, equilibria is done with a novel technique known as stochastic response dynamic, which does not require computation of first-order conditions.

That is what Judge Posner has to say about Leegin in his new book, How Judges Think.   I’m only a few chapters in, but so far, its a fascinating read.  I’ll probably blog some more about parts of the book later.  In particular, I’ve been thinking recently about how the complexity of substantive antitrust analysis affects judicial decision-making.  But for now I wanted to just post an excerpt from the book containing Posner’s description of Leegin (TOTM posts on Leegin are here):

The earlier case [ed: Dr. Miles]  had held that agreements by which a manufacturer places a floor under his distributors’ resale price are a per se violation of the Sherman Act, on the ground that they have the same effect as if the retailers had gotten together and decided to fix a minimum price at which to sell the good.  That was wrong as a matter of economics, because a manufacturer has no interesting in allowing his distributors to cartelize distribution, thus restricting his access to his customers.  If the manufacturer places a floor under his retailers’ prices, it is because the floor serves his interest in competing more effectively against other manufacturers, as by encouraging the retailers to provide presale services to customers for the manufacturer’s good.  So Dr. Miles was rightly overruled.  But the overruling, and its rightness, owed nothing to legalist thinking.  A venerable precedent was overruled because it was bad economics.  Leegin is a triumph of pragmatism.

Posner also describes Bell Atlantic v. Twombly (p. 53-54) as a pragmatic decision, noting that “nothing in the repertoire of legalism could have decided it, especially in favor of the position in the majority opinion” and concluding that “right or wrong, the decision in Bell Atlantic pragmatic rather than legalist.”  If Leegin is a “triumph of pragmatism,” is the continuing vitality of Jefferson Parish’s “per se” prohibition against tying a failure of pragmatism?  If my prediction is correct, whether pragmatic or otherwise, it won’t be too long before Jefferson Parish joins Dr. Miles.

The Financial Times reported yesterday that an embarrassed GE CEO Jeffrey Immelt had to tell GE shareholders that the 10% growth in earnings for 2008 that he had promised analysts in March was not going to be possible.  GE missed its quarterly forecasts and halved its 2008 forecast to 5% growth in earnings (as opposed to the 10% growth promised).  The Financial Times article mentioned a “sense of shock among the investor community” and noted that one analyst, after Immelt’s downward revision, “compared GE’s promise of long-term improvements to the Chicago Cubs, the US baseball club that hasn’t won a championship in 100 years.” 

Upon reading this FT article this morning, I thought “oh, dear God.  Do we remember none of the lessons learned just a few years ago about the perils of over-promising results to analysts?”  Why, exactly, does Immelt feel the need to promise a 5% increase in earnings for 2008 when (a) we are in a credit crunch, (b) GE is likely going to have to do more write-downs this year, (c) the cost of inputs is increasing, if not skyrocketing, (d) inflation is high, and (e) the economy is weak (among other things)?  Why is Immelt promising *growth* in earnings when the reality is that just achieving positive earnings for 2008 is likely to be good thing?  Why is Immelt putting pressure on himself and his officers to produce growth? 

Memo to Immelt:  Earnings do not have to grow each year.  In some markets, in some economies, in some industries, in some “downturns,” simply having earnings – any positive earnings – is a good thing.  Matter of fact, sometimes earnings should NOT be growing each year.   Were I a GE investor, I would not want Immelt promising 5% growth for 2008 because I would figure that the only way he can promise to hit that number in such an uncertain market and gloomy economy is by commiting to fudge year-end 2008 numbers if needed.  And, as we learned several years ago, fudging year-end numbers tends to catch up with companies, and, when it does catch up, the valuation fall-out is worse than if the forthright disclosure (e.g. “2008 earnings might be flat”) had been made initially. Am I the only one who remembers back to the not-so-distant past, when unrealistic promises made to analysts by corporate officers led to companies cooking their books at year end to make the numbers?  As I recall, things did not always work out so well in those cases.  Enron, anyone? 

Surely it is enough for a company in some years to produce returns that are merely equal to the prior year’s, as opposed to “besting” the prior year’s earnings. Didn’t we learn this lesson several years ago?  Investors are supposed to invest for the long term and diversify.According to the FT, one of the reasons why GE missed its quarterly numbers recently is because GE was unable to close “$900m-worth of real estate asset sales,” which the FT referred to as “a traditional way for GE to boost quarterly returns.”  If I were a GE investor, I would be peeved to read this.  I would rather GE just do the real estate deals when they make the most sense, when the market is most favorable for the deals at issue, regardless of when the gain/loss woulbe be booked.  If that means GE misses its numbers sometiemes due to the lack of a crystal ball regarding the best time to sell the assets, and I take a short-term valuation hit (on paper) as a GE investor, so be it.   It doesn’t create long-term value for shareholders if GE rushes through real-estate transactions just to make the numbers if the timing is not sensible for the transactions and waiting a little bit of time would garner value for shareholders.(The FT reports that “GE slashed its 2008 earnings forecast from $2.42 per share to $2.20-$2.30 – still an increase of as much as 5 per cent from last year.”  Slashed?  Slashed?  Are you KIDDING me?  “Slashed” implies something negative.  Earnings of $2.20-$2.30 per share for a year that is not likely to shape up particularly well  would be good.)

Northwestern University School of Law’s Searle Center on Law, Regulation and Economic Growth will be holding a conference on Antitrust Economics and Competition Policy on September 26-27th.  From the Call for Papers:

The goal of this Research Symposium is to provide a forum where leading scholars from across the country can gather together with Northwestern’s own distinguished faculty to present and discuss high quality research relevant to antitrust economics and competition policy. Both theoretical and empirical submissions are welcome. Papers in industrial organization or applied microeconomic theory that address issues relevant to antitrust policy are welcome even if they do not directly focus on particular antitrust policy issues or institutions. We hope to involve leading thinkers from the government, non-profit, and private sector, as well as leading academics from economics departments, business schools, law schools and public policy schools. While most of the conference will be devoted to presentation and discussion of original academic research, we also expect to schedule a small number of panels on important current topics or policy issues. If you have questions about the appropriateness of your paper for the symposium, or suggestions for panel subjects, please contact Professor William Rogerson, Research Director, Searle Center Research Project on Competition, Antitrust and Regulation (wrogerson@northwestern.edu)

NOTE: The deadline for abstracts is April 15, 2008!

I am blogging today from the Tulane Corporate Law Institute, here in New Orleans, at the stunning Westin Hotel. I am set to appear on the Private Equity panel tomorrow, where I will talk about, among other things, the implications of 2007’s string of failed private equity deals.  In preparation for this conference, I drafted a memo on the top few lessons to learn from the 2007 private equity deals. Among the lessons learned, I observed, was that “merger agreements mean what they mean.” What I was referring to was the string of deals that got into trouble in 2007 because the buyers tried to evade the deals, arguing that there was a material adverse change in the condition of the target, and the sellers tried to press for specific performance, in the shadow of a merger agreement that was clear on neither the definition of material adverse change nor when specific performance was justified. 

Deal lawyers have long kept the not-so-secret secret that we really don’t know what most material adverse change provisions mean, in the abstract. If pressed, we might admit that, indeed, they are often painfully ambiguous. We cannot necessarily opine, again in the abstract, whether they would cover a given set of facts. And we are ok with that because we like the idea that, in court, we can argue whatever way will help our case (that there was or was not a material adverse change).

Setting aside the “we,” and speaking no longer as a deal lawyer but as a corporate governance aficionado, I have to say that I have long thought that target boards of directors should not be ok with signing off on material agreements – merger or otherwise – that are not clear (at least on material points). Or boards should not be content to sign off until they understand why the ambiguity is acceptable. The reality is that I suspect that little has changed since Smith v. Van Gorkom, where the Trans Union board never even *saw* the merger agreement, much less read it and debated “material adverse change” provisions. And that troubles me.

Today’s panels here at the Deals Conference confirmed my concerns. Three people made interesting comments: First, a high-profile investment banker made clear that the bankers just don’t *know* what events fall within “material adverse change,” such that the deal could fall apart. Meaning, the investment bankers don’t really know how the merger agreement language reads, as a legal matter. (This is not surprising in light of the URI case opinion making clear that UBS (bankers for URI) had no idea they were basically selling an option on URI (as opposed to signing a deal to buy URI).) My view is that, since bankers are the ones STRUCTURING financial aspects of the deal and opining on the totality of the deal, including pricing of the risk that the deal will not consummate, they need to be very clear on what can implode the deal and how the risks of non-consummation due to “material adverse change” play out. Second, a high-profile deal lawyer on the same panel both (a) basically confirmed that we are still in a deal world where the “material adverse change’ language is admittedly looser than it could be and (b) confirmed that deals would still get signed even if the target board insisted on tighter materiality language. Third, Vice Chancellor Strine opined that …. “[i]f I were going to obsess about something, it would be Keira Knightley.” I seem to have been distracted by that comment, because, though Strine later *did* say something about “material adverse change,” I failed to write it down. I do believe Strine said something to the effect that boards should understand, prior to signing, what a material adverse change that would get the buyer out of the deal would include.

So where do we end up? We end up right where we have always been. It is not ideal to have merger agreements with ambiguous “material adverse change” language. But everyone – drafting lawyers, investment bankers, boards- seems to let it slip by. It is only a matter of time before a target board gets successfully sued in a fiduciary duty lawsuit for failing to act “in good faith” by signing a *sale* document without reading it and realizing it is ambiguous on an important topic. Then it is only a matter of time before the board spins around and sues both (a) their lawyers and (b) their bankers for failing to explain the deal-impacting aspects of the deal terms struck (such as “material adverse change,” specific performance conditions, and reverse termination fee outs). Mark my words. You heard it here first.