American University Law Review Volume 49 | Issue 2 Article 1 1999 The Law-and-Markets Movement Michael Abramowicz Follow this and additional works at: http://digitalcommons.wcl.american.edu/aulr Part of the Banking and Finance Commons Recommended Citation Abramowicz, Michael. “The Law-and-Markets Movement.” American University Law Review 49, no.2 (December 1999): 327-431. This Article is brought to you for free and open access by the Washington College of Law Journals & Law Reviews at Digital Commons @ American University Washington College of Law. It has been accepted for inclusion in American University Law Review by an authorized administrator of Digital Commons @ American University Washington College of Law. For more information, please contact [email protected]. The Law-and-Markets Movement Keywords Finance, Tort claims, bankruptcy, auction, Self-Assessment, Market Mechanisms This article is available in American University Law Review: http://digitalcommons.wcl.american.edu/aulr/vol49/iss2/1 ARTICLES THE LAW-AND-MARKETS MOVEMENT * MICHAEL ABRAMOWICZ Commentators increasingly have suggested market-based approaches to legal problems. These proposals, which range from tort-claims trading to bankruptcy auctions, rely on the information-processing capacity of capital markets to enhance existing legal institutions and to eliminate the need for some kinds of decisionmaking altogether. In this Article, Professor Abramowicz collects, critiques, and extends these proposals, describing various kinds of capital market mechanisms and imagining a number of potential legal uses. For market-based legal institutions to be viable, certain technical problems with capital market mechanisms, such as the potential for collusion, must be overcome. Such vulnerabilities are not intractable, however, and the solution often lies in using one type of market mechanism to address a weakness in another. By combining auction, exchange, and self-assessment, the Article constructs a “comprehensive market mechanism,” a general purpose tool for objectively predicting dollar amounts or other numbers useful for legal decisionmaking. * Assistant Professor, George Mason University School of Law; Visiting Assistant Professor, Northwestern University School of Law. J.D., Yale Law School; B.A., Amherst College. I would like to thank participants in faculty workshops at the George Mason University School of Law, the Northwestern University School of Law, the University of Pennsylvania Law School, the University of Wisconsin Law School, and the Wharton Department of Legal Studies. Any remaining errors in the Article could be corrected by the creation of an appropriate market mechanism. 327 328 AMERICAN UNIVERSITY LAW REVIEW [Vol. 49:327 TABLE OF CONTENTS Introduction........................................................................................ 328 I. Three Types of Market Mechanisms........................................ 335 A. Auction............................................................................... 335 B. Exchange............................................................................ 352 C. Self-Assessment .................................................................. 364 II. The Virtues and Vices of Market Mechanisms........................ 373 A. Virtues ................................................................................ 374 1. Assimilation of existing information........................... 375 2. Information production .............................................. 378 3. Unbiased decisionmaking ........................................... 381 4. Management of scarce resources ................................ 384 5. Allocation to the highest valuing user ........................ 387 B. Vices.................................................................................... 389 1. Manipulability............................................................... 390 2. Competitiveness ........................................................... 393 3. Winner’s curse.............................................................. 397 4. Market risk.................................................................... 400 5. Transactions costs ........................................................ 402 6. Inability to pay.............................................................. 406 III. Market Mechanisms and Legal Values .................................... 408 A. Process Values.................................................................... 409 1. Accuracy........................................................................ 409 2. Consistency................................................................... 415 3. Efficiency ...................................................................... 417 B. Democratic Values............................................................. 419 1. Accountability............................................................... 419 2. Transparency................................................................ 421 3. Participation ................................................................. 424 C. Institutional Values............................................................ 425 1. Legitimacy .................................................................... 425 2. Expressivity ................................................................... 428 3. Continuity..................................................................... 429 Conclusion........................................................................................... 430 INTRODUCTION The decisionmaking institutions of finance and law are so different that any attempt to apply the mechanisms of one to the other seems almost unthinkable. As evidence, imagine the reaction to the modest proposals of two very different scholars. Roberto Unger urges that we not leave investment to the invisible hand.1 Instead, all of society’s 1. See ROBERTO MANGABEIRA UNGER, FALSE NECESSITY: ANTI-NECESSITARIAN SOCIAL THEORY IN THE SERVICE OF RADICAL DEMOCRACY 491-96 (1987) (proposing reorganization and restructuring of the economy). 1999] THE LAW-AND-MARKETS MOVEMENT 329 financial capital should be distributed through a three-tiered quasi- governmental structure.2 Meanwhile, A.C. Pritchard argues that the courts ordinarily should not assign appellate counsel to convicted indigent defendants.3 The right to serve as appellate counsel, he maintains, should be auctioned to the highest bidder, who would receive a contingency fee from the government if the appeal were successful.4 Most lawyers, financiers, and academics surely would find both proposals unattractive, at least on first impression. Yet they reflect nearly opposite premises. Unger’s implies that stock and bond markets are inadequate means of making important social decisions about how resources should be allocated. Pritchard’s suggests that competitive auctions are an effective way of making such decisions. Unger rejects capital market mechanisms, Pritchard embraces them, and most of us, it seems, are as reluctant to abandon such mechanisms for questions of finance as we are to adopt them for questions of law. In this Article, I seek to undermine this divide. I cannot claim to be neutral between Unger’s and Pritchard’s views of capital market mechanisms. Although at times I will point out the limitations of capital market mechanisms and indicate how these weaknesses support Unger’s position on capital markets,5 my thesis is that capital market mechanisms have strengths that our legal institutions might, in certain circumstances, harness. Legal systems process information about facts, law, and policy preferences.6 Capital markets process 2. Unger describes his three-tiered proposal in the following passage: The key idea of the institutional proposal is the breakup of control over capital into several tiers of capital takers and capital givers. The ultimate capital giver is a social capital fund controlled by the decisional center of the empowered democracy: the party in office and the supporting representative assemblies. The ultimate capital takers are teams of workers, technicians, and entrepreneurs, who make temporary and conditional claims upon divisible portions of this social capital fund. The central capital fund does not lend money out directly to the primary capital users. Instead, it allocates resources to a variety of semi-independent investment funds. Each investment fund specializes in a sector of the economy and in a type of investment. Id. at 491. For a critique, see David E. Van Zandt, Commonsense Reading, Social Change, and the Law, 81 NW. U. L. REV. 894, 923-24 (1987). More generally, see William Ewald, Unger’s Philosophy: A Critical Legal Study, 97 YALE L.J. 665, 668 (1988). 3. See A.C. Pritchard, Auctioning Justice: Legal and Market Mechanisms for Allocating Criminal Appellate Counsel, 34 AM. CRIM. L. REV. 1161, 1166-70 (1997) (describing the problems that arise when all convicted indigent defendants are assigned counsel). 4. See id. at 1170-71 (proposing the idea of auctioning the right to represent defendants on appeal). 5. See, e.g., infra note 367 and accompanying text. 6. Typically, juries process factual information, judges process the law, and legislatures process policy preferences. Of course, the characterization of legal decisionmakers as information processors obscures the normative component of 330 AMERICAN UNIVERSITY LAW REVIEW [Vol. 49:327 information too. For example, stock prices reflect many variables including weather