40081-gme_14-1 Sheet No. 1 Side A 04/05/2018 09:40:07 File: 00. Masthead - 14.1 - Fall 2017 Created on: 3/9/2018 6:38:00 PM Last Printed: 4/3/2018 7:31:00 PM JOURNAL OF LAW,ECONOMICS &POLICY VOLUME 14 FALL 2017 NUMBER 1 EDITORIAL BOARD 2017-2018 Bonnie M. Kelly Editor-in-Chief Steven Horn Erich D. Grome Brian Silver Executive Editor Publications Editor Senior Notes Editor & Managing Editor Samantha Trussell Ray Samara Emily Yu Senior Articles Editor Senior Research Editor Communications Director & Articles Selection Editor MEMBERS Taylor Alexander Julian Flamant Chris Marchese Ian Beckelman Lauren Holmes Katherine M cKerall Caroline Grace Brothers Brandon Howell Ayanna McKinnon Jack Brown Casey Hunt Connor Mosey Thomas Burnham Lucia Jacangelo Brandon Peterson Lindsey Davis Rebecca Jodidio Tyler Phelps Taylor Kelly Emile Khattar BOARD OF ADVIS ORS 40081-gme_14-1 Sheet No. 1 Side A 04/05/2018 09:40:07 Lisa E. Bernstein Henry N. Butler Judge Guido Calabresi Lloyd R. Cohen Robert D. Cooter Robert C. Ellickson Richard A. Epstein Judge Douglas H. Ginsburg Mark F. Grady M ichael S. Greve Bruce H. Kobayashi Francesco Parisi A. Douglas M elamed Judge Richard A. Posner Eric Posner Hans-Bernd Schafer Roberta Romano Henry E. Smith Steven M . Shavell Gordon Tullock Vernon L. Smith W. Kip Viscusi Thomas S. Ulen Todd J. Zywicki i 40081-gme_14-1 Sheet No. 1 Side B 04/05/2018 09:40:07 File: 00. Masthead - 14.1 - Fall 2017 Created on: 3/9/2018 6:38:00 PM Last Printed: 4/3/2018 7:31:00 PM 40081-gme_14-1 Sheet No. 1 Side B 04/05/2018 09:40:07 ii 40081-gme_14-1 Sheet No. 2 Side A 04/05/2018 09:40:07 File: 00. Masthead - 14.1 - Fall 2017 Created on: 3/9/2018 6:38:00 PM Last Printed: 4/3/2018 7:31:00 PM JOURNAL OF LAW,ECONOMICS &POLICY VOLUME 14 FALL 2017 NUMBER 1 CONTENTS ARTICLES 1 PENSION FORFEITURE AND POLICE MISCONDUCT D. Bruce Johnsen & Adam David Marcus 35 PUBLIC PENSION FUND INVESTM ENTS: THE ROLE OF GOVERNA NCE STRUCTURES Odd J. Stalebrink 61 A JUDGE IN THEIR OWN CAUSE: GASB 67/68 AND THE CONTINUED MIS- MEASUREMENT OF PUBLIC SECTOR PENSION LIABILITIES Sheila Weinberg & Eileen Norcross 91 RECOGNIZING TAXPAYERS AS STAKEHOLDERS IN MUNICIPAL BANKRUPTCIES Diane Lourdes Dick 107 THERE IS A TANGLED WEB OF FACTORS CAUSING INAPPROPRIATE PENSION FUNDING BEHAVIOR Anthony Randazzo 127 THE IMPACT OF DISTRICT ELECTIONS ON MUNICIPAL PENSIONS AND INVESTM ENT Richard T. Boylan & Dru Stevenson 151 THE LEAD LEMMING: ILLINOIS ON THE PENSION-CRISIS BRINK Scott Andrew Shepard 40081-gme_14-1 Sheet No. 2 Side A 04/05/2018 09:40:07 iii 40081-gme_14-1 Sheet No. 2 Side B 04/05/2018 09:40:07 File: 00. Masthead - 14.1 - Fall 2017 Created on: 3/9/2018 6:38:00 PM Last Printed: 4/3/2018 7:31:00 PM 40081-gme_14-1 Sheet No. 2 Side B 04/05/2018 09:40:07 iv 40081-gme_14-1 Sheet No. 3 Side A 04/05/2018 09:40:07 File: 01 Johnsen & Marcus.docx Created on: 3/9/2018 5:24:00 PM Last Printed: 4/2/2018 4:07:00 PM 2017] 1 PENSION FORFEITURE AND POLICE MISCONDUCT D. Bruce Johnsen & Adam David Marcus INTRODUCTION Empirical work on efficiency wages suggests that private sector de- fined benefit (DB) pension plans worked for many years to attract and re- tain high-quality workers.1 Critical to building and maintaining a high- quality workforce was the ability to terminate employees who revealed their low quality in the form of misconduct such as negligence, subordination, dereliction of duty, or theft. Prior to passage of the Employee Retirement Income Security Act (ERISA), the prospective loss of pension benefits for misconduct fed into the system to screen out low-quality workers from the start.2 Once ERISA mandated shorter vesting periods and prohibited pen- sion forfeiture for misconduct the efficiency enhancing attributes of private sector pensions waned, as did their popularity.3 With employers unable to punish worker misconduct with pension forfeiture, it is plausible to assume the incidence of misconduct increased and that the up-front screening effect of prospective pension forfeiture was lost as well. This article applies the theory of efficiency wages4 to public sector pension-covered workers for whom employee misconduct is most trouble- some, namely state and local police. No doubt most police are conscien- 1 RICHARD A. IPPOLITO, PENSION PLANS AND EMPLOYEE PERFORMANCE:EVIDENCE,ANALYSIS, 40081-gme_14-1 Sheet No. 3 Side A 04/05/2018 09:40:07 AND POLICY 107 (Univ. Chi. Press, 1997); Richard A. Ippolito, A Study of the Regulatory Effect of the Employee Retirement Income Security Act, 31 J. L. & ECON. 85, 114 (1988). 2 IPPOLITO, supra note 1, at 107; See generally Ippolito, supra note 1. 3 See generally IPPOLITO, supra note 1; Ippolito, supra note 1, at 98. 4 See generally EFFICIENCY WAGE MODELS OF THE LABOR MARKET, (George A. Akerlof & Janet L. Yellen eds., Cambridge Univ. Press 1986); George A. Akerlof, Labor Contracts as Partial Gift Exchange, 97 Q. J. ECON. 543 (1982); George A. Akerlof & Janet L. Yellen, The Fair Wage-Effort Hypothesis and Unemployment, 105 Q. J. ECON., no. 2, 1990, at 255; Daniel M. G. Raff & Lawrence H. Summers, Did Henry Ford Pay Efficiency Wages?, 5 J. LAB.ECON., no. 4, 1987, at S57; Steven C. Salop, A Model of the Natural Rate of Unemployment, 69 AM.ECON.REV., no. 1, 1979, at 117; Carl Shapiro & Joseph E. Stiglitz, Equilibrium Unemployment as a Worker Discipline Device, 74AM.ECON. REV., no. 3, 1984, at 433; Joseph E. Stiglitz, The Causes and Consequences of the Dependence of Quali- ty on Price, 25 J. ECON.LITERATURE, no. 1, 1987, at 1. Efficiency wage theory asserts that the structure and magnitude of wages positively affects employee and employer incentives to provide inputs that are otherwise noncontractible. The structure of DB pensions has been recognized in the labor economics literature as one component of an efficiency wage, that is, a pattern of conditional wage payments providing both employees and employers with high-powered incentives to maximize joint surplus. To the extent police misconduct results not only in pension losses on termination, but the potential for complete pension forfeiture, the cost of misconduct to potential offenders increases and we should expect its frequency to diminish, perhaps substantially. 40081-gme_14-1 Sheet No. 3 Side B 04/05/2018 09:40:07 File: 01 Johnsen & Marcus.docx Created on: 3/9/2018 5:24:00 PM Last Printed: 4/2/2018 4:07:00 PM 2 JOURNAL OF LAW,ECONOMICS AND POLICY [VOL. 14.1 tious professionals capable of addressing tense or inflamed situations with the proper amount of restraint, but there is also a large and rising incidence of police excessive use of force and other forms of misconduct that needs to be addressed. At the same time, state and municipal pension systems are frighteningly underfunded owing to unrealistically high rate-of-return as- sumptions and implausibly high rates at which liabilities are discounted,5 with several bankruptcies having already occurred or in process.6 Robert Novy-Marx and Joshua Rauh put total underfunding across all 50 states between $1.26 and $2.49 trillion as of June, 2009.7 This paper examines how the rules regarding police pension forfeiture for misconduct vary across states and whether stricter forfeiture might help avoid fiscal crisis. The positive questions we ask are whether stricter pen- sion forfeiture rules can realistically reduce either (1) pension liabilities owing to the increased prospect of for-cause termination or (2) state and municipal governments’ legal liability under respondeat superior for officer misconduct. If the answer is yes to either question, the normative question is whether states can and, if so, should impose stricter pension forfeiture rules to directly or indirectly avert the looming public pension crisis. If not, the conclusion is that the use of public pensions to provide efficiency wages is severely limited, and that serious thought should be given to abandoning DB plans going forward in favor of defined contribution (DC) plans, which are far less costly to administer. Our initial and admittedly casual evidence suggests that states with stronger pension forfeiture laws experience lower rates of police miscon- duct. Drawing any causal inference from this evidence requires far more data and rigorous empirical testing. Even if stricter police pension forfei- ture is found to materially reduce the incidence of misconduct, the compel- ling conclusion is that it is unlikely to materially mitigate the looming pub- 40081-gme_14-1 Sheet No. 3 Side B 04/05/2018 09:40:07 lic pension crisis because the amount of money at stake is so small. It is plausible, however, that the indirect fiscal effect of stricter police pension forfeiture for misconduct could be substantial because municipalities across the country currently pay out hundreds of millions of dollars annually on citizen suits for excessive use of force. With police pensions contingent on good faith performance in the line of duty, it is uncontroversial that mis- conduct will decline as the expected losses from misbehavior increase. 5 See, e.g., Robert Novy-Marx & Joshua Rauh, Public Pension Promises: How Big are They and What are They Worth?, 66 J. FIN., no. 1, 2011, at 1211, 1213; see also PAULA SANFORD &JOSHUA M. FRANZEL, THE EVOLVING ROLE OF DEFINED CONTRIBUTION PLANS IN THE PUBLIC SECTOR (2012), http://www.nagdca.org/portals/45/ANC_NAGDCA_SLGE_The_Evolving_Role_of_Defined_Contribut ion_Plans_in_the_Public_Sector2.pdf. 6 Detroit is the most obvious example.