Law Review Network

Regulation in the Behavioral Era

by John Doe

Individuals do not always respond to regulation as Homo economicus, and administrative agencies have finally begun to notice.1 The fact that individuals deviate in predictable ways from neoclassical assumptions of rationality has been widely recognized in the academic literature and has become well known to the public.2 But only recently has it begun to shape regulatory policy.3 Agencies have begun to develop regulations and policies that reflect the insights of behavioral economics,4 and the Office of Information and Regulatory Affairs (OIRA) within the Office of Management and Budget (OMB) has intro- duced behavioral economics to White House review of agency regulations.5 As a result, the influence of behavioral economics on agency decisionmaking is likely to grow substantially. Regu- lation has entered the behavioral era.

Although behavioral research is often referred to as “beha- vioral economics,” economists are not the only sources of in- sight for making regulation sensitive to the ways in which indi- viduals depart from the traditional rational-actor model. Somewhat overshadowed in the public and policymaking world are the important insights of other fields within the behavioral and social sciences. These insights suggest, for example, that it may be as important for regulators to account for descriptive and prescriptive norms as for the insights of behavioral eco- nomics, such as framing, hyperbolic discounting, loss aversion, and so on.6 Taken together, the behavioral and social sciences suggest that a multitude of factors beyond price explain the va- riability in human behavior, and understanding these factors can make regulation more effective.7 For simplicity, we refer in this Article to behavioral economics and the related behavioral and social sciences as “behavioral science,” although we note that the term as we refer to it includes a wide range of fields, such as sociology and social psychology, that are more common- ly referred to as social science.8

Behavioral insights are important at three critical stages in the regulatory process. First, they can help to improve the manner in which agencies develop regulatory options early on in the regulatory process.9 A quick illustration is helpful. Al- though electric cars have the potential to reduce carbon- and other air-emissions, recent studies suggest that their impact and cost may vary dramatically based on whether drivers re- charge their vehicles at peak or off-peak periods (e.g., when they arrive home from work, or in the middle of the night).10

In the Shadow of the Omnipresent Claw

by Michael C. Macchiarola

As the American economy continues to totter against an ever-growing populist momentum, it seems likely that claw- back mechanisms of various sorts will be put to increasing use in the coming months and years.1 Very generally, a clawback attempts to regain previously conferred monies or benefits fol- lowing a certain triggering event, usually involving some change in circumstances. In a sense, clawbacks offer the oppor- tunity for a “do-over”—a convenient antidote to both the uncer- tainty that characterizes American financial markets and the calls for accountability that grow louder with each corporate misstep, real or perceived.2 Yet, as Professors Cherry and Wong note in Clawbacks: Prospective Contract Measures in an Era of Excessive Executive Compensation and Ponzi Schemes (the “Ar- ticle”), the term clawback “has been subject to neither rigorous analytical scrutiny nor definition and exposition.”3 Against this backdrop, the authors’ undertaking to advance a so-called doc- trine of clawbacks is both bold in its aspiration and laudable in its result. The Article succeeds in establishing a firm founda- tion for additional examination and discovery and highlights the importance of clear rules of the road to guide all market participants.

This Response (the “Response”) attempts to bolster and improve upon the still nascent discussion surrounding claw- backs. Moreover, the Response challenges Professors Cherry and Wong, and the academic community more broadly, to ad- dress a number of questions that remain unsettled. It seems in- tuitive that the retroactive imposition of clawbacks, by legisla- tion or otherwise, is less desirable than more prospective efforts.4 Yet, the complexity of the subject matter demands more than a reflexive call for the organic inclusion of clawback provisions in investment contracts or compensation agreements as a matter of course.

Reply: Clawback to the Future

by Miriam A. Cherry and Jarrod Wong

In Clawbacks: Prospective Contract Measures in an Era of Excessive Executive Compensation and Ponzi Schemes (the “Ar- ticle”), we undertook the task of proposing a doctrine of claw- backs that would not only furnish a framework for analyzing the term more systematically, but would also describe the ways the doctrine would relate to established rules of contract law.1 With his response, In the Shadow of the Omnipresent Claw: In Response to Professors Cherry & Wong (the “Response”),2 Mi- chael Macchiarola has provided us with an opportunity to arti- culate these thoughts on the doctrine of clawbacks further, and for that opportunity and his careful reading of the Article, we thank him.

In essence, the Response takes issue with the Article in three respects;3 first, with what it terms the “newer” applica- tion of clawbacks to “the recoupment of corporate executive compensation”4; second, with the purported “latent subjectivity” of clawbacks generally;5 and third, with the apparent opera- tional difficulties of implementing prospective clawbacks, including those relating to measurement and enforcement.6 As for the first critique questioning the application of clawbacks to executive compensation, recent events, including the passage of the Dodd-Frank Act blunts the extent of the criticism. The Dodd-Frank Act, which establishes mandatory clawback poli- cies in the event of an accounting restatement, ensures that clawbacks will be a significant part of the executive compensa- tion landscape for the foreseeable future.

As to the second critique, we agree to some extent with the Response that clawbacks and the concept of unfair enrichment that we described may increase the overall complexity of con- tracts. However, the additional complexity that the Response complains of arises in many instances in which an equitable remedy exists. In this way, the clawback doctrine operates no differently from many existing equitable doctrines, including, for example, its close cousin, the doctrine of unjust enrichment. Moreover, like these other doctrines, the parameters of the doc- trine can and will only be more precisely delineated with time. Further, many of the Response’s fundamental objections to clawbacks on account of their “subjectivity” apply only to ret- roactive clawbacks, and not to prospective clawbacks. It bears noting, therefore, that the Article draws and, indeed, empha- sizes the critical distinction between the two. We not only iden- tify and explain the difficulties associated with the retroactive imposition of clawbacks, but affirmatively recommend writing clawback provisions into contracts prospectively.