Law and Decisions in Corporations

This dissertation studies the impact of corporate laws and bankruptcy laws on decisions in corporationsfrom a theoretical perspective. Chapter 1 studies the impact of liability rules on firms’ choices of care (affecting the frequency of tort damages) and scale (level of output) at the extensive and intensive margins. Chapter 2 focuses on gambling using derivatives, made more available by recent changes in the bankruptcy law granting repos and other derivatives “superpriority,” which is exemption from the automatic stay and clawback in bankruptcy. Limited liability is a birth right given by law to corporations, LLCs, and to differing extents specialforms of partnerships (LPs, LLPs, and LLLPs). Chapter 1 starts with a question: does limited liability on damages improve social efficiency? The results show that when the outside stakeholders (consumers, employees, suppliers, communities, governments, etc.) obtain benefits from the firm, the tradeoff between damages to the tort claimants and benefits to the outside stakeholders determines the efficiency of liability rules. Full liability induces efficient care but also increases marginal and average costs, inducing less-than-efficient scale. Limited liability externalizes some damages, resulting in less than efficient care, but the higher profitability encourages larger intensiveand extensive margins for scale than full liability. Compared to full liability, limited liability tends to be more efficient if the benefits from larger scale covers the loss from lower care, i.e., if the outside stakeholders have a larger potential value. As potential value to the outside stakeholders falls, the equilibrium with full liability converges to the first best, whereas the equilibrium with limited liability deviates from the first best, encouraging low care level and large scale. Therefore, limited liability is not a one-size-fits-all policy to achieve the optimum for different firms. This opens up possibilities of other rules, for example requiring insurance for some activities, to adjust for cross-firm differences. Chapter 2 is a joint work with Philip Dybvig. Myers (1977) described how firms can gamble usingasset substitution, which is switching to a less efficient and more volatile project. Gambling using derivatives is a sharper instrument, allowing the firm to gamble just to what is needed, and with negligible efficiency loss. In our model, “gambling for redemption” operates at small scale and is socially beneficial, while “gambling for ripoff” operates at large scale and is socially inefficient but benefits stockholders at the expense of bondholders. Superpriority laws reduce firm value by making it harder for firms to borrow due to the anticipation of gambling for ripoff