Peevyhouse v. Garland Coal & Mining Co.
Bargaining for Subjective Value:
‡Lease term: 5 year lease for $L + the performance of certain
restorative and remedial work.
‡Total value of lease to Peevyhouse with restoration is:
$T = $L - (V/r)(1-1/(1+r)6) > 0
Where V = per year value (including subjective value) of
restoration and remedial work promised (restoring land as a
farm).
‡Profits to Garland = (Coal Profits) ± $L ± $R > 0,
George Mason University School of Law
Law & Economics Center
Peevyhouse v. Garland Coal & Mining Co.
Damages: Cost of completion (R) versus diminution in value
(D).
‡Cost of restoration R = $29,000
‡Diminution in the Market Value of the Farm D = $300
‡R >> D
‡Apply D DVPHDVXUHRIGDPDJHVXQGHU³HFRQRPLFZDVWH´UXOH
(when R >> D).
‡Plaintiffs sued for $25,000.
‡Trial Damages $5,000 (more than total value of the farm after
remedial work has been done).
‡Reduced to $300 by SCT of OK.
George Mason University School of Law
Law & Economics Center
Peevyhouse v. Garland Coal & Mining Co.
‡What LVWKHFRQVHTXHQFHRIWKHDSSOLFDWLRQRIWKHUHVWDWHPHQW¶V
³XQUHDVRQDEOHHFRQRPLFZDVWH´UXOHRUDOWHUQDWLYHO\WKH0F&RUPLFNUXOH
UHJDUGLQJWKHUHODWLRQVKLSEHWZHHQWKHH[SHQVHLQYROYHGDQGWKH³HQGWREH
DWWDLQHG´
‡Ex-ante, if contract with restoration is anticipated not to be enforced
under unreasonable economic waste rule, value of Lease to
Peevyhouse family must be greater than loss of use of farm for 5 years
7¶ /'- (V/r) < 0 if V/r large relative to $L + $D.
‡Anticipation of rule will not result in similar contracts going forward.
‡Increase explicit lease payment to $L* = $L + $R? (Indeed if the impact
of the opinion is that [the plaintiff] must redraft its contracts to achieve
the same economic results, the decision is not only wrong but
conspicuously ineffectual ± Justice Harlan in Brulotte v. Thys)
‡Efficient breach versus opportunism?
George Mason University School of Law
Law & Economics Center
Market Prices as Information
Information Markets (Intrade)
George Mason University School of Law
Law & Economics Center
Stock Market Event Studies: Backdating
April 16, 2007 ±
The Wall Street Journal won the Pulitzer Prize for
Public Service today for uncovering the unethical
practices of business executives who had rewarded
themselves millions of dollars by backdating stock
options.
The articles, by Charles Forelle, James Bandler and
Mark Maremont, have led to the federal investigation
of more than 130 companies, and at least 70 top
executives have lost their jobs.
George Mason University School of Law
Law & Economics Center
Stock Market Event Studies: Backdating
Academic Event Studies by Lie, Heron & Lie:
‡ Backdating discerned from pattern of
abnormal returns around executive option
grants.
± Stock returns abnormally negative before
executive option grants.
± Stock returns abnormally positive
afterward.
George Mason University School of Law
Law & Economics Center
Stock Market Event Studies: Backdating
P(t<0)
Stock Price
Forward dating
option issued at t<0
to t=0 allows
avoidance of out of
the money option.
Backdating option
issued at t>0 to t=0
yields in the money
option with at the
money tax and
regulatory
treatment
P(t=0)
George Mason University School of Law
P(t>0)
Time
Law & Economics Center
Stock Market Event Studies: Backdating
‡ Pattern weaker after 8/29/2002 (new SEC 2
day reporting regulation).
‡ Pattern disappears for option grants
reported on the same day as the grant.
‡ Persists but smaller for those reported
with lag within the 2 day period.
‡ Largest for grants where firm violated 2
day reporting requirement.
George Mason University School of Law
Law & Economics Center
Stock Market Event Studies: Backdating
George Mason University School of Law
Law & Economics Center
Event Studies and Antitrust
‡ Use of stock price data to test (examine) whether or
not merger is anticompetitive.
‡ Theory: CAPM & Informationally Efficient Markets
‡Under informationally efficient markets, we can identify
pattern of abnormal returns to obtain market based evaluation
of the merger and complaint.
‡7KLVHYDOXDWLRQLVEDVHGRQWKHPDUNHW¶VEHVWHVWLPDWHRIWKH
likely sources of gain from the merger.
‡ Data
‡CRSP daily stock database
‡ Specification
‡Simple linear regression
George Mason University School of Law
Law & Economics Center
Testable Hypotheses
Table 1 (From Eckbo and Weir, p 124)
Abnormal Returns to the Merging Firms and Their Rivals as Predicted Under the Market Power and
Economic Efficiency Hypothesis
A. Probability Increasing Events: Merger Proposal or Prodefendant Decision
Theory Predicting the
Source of Merger Gains
Market Power:
Collusion, Cournot Model
Predatory Pricing Model
Economic Efficiency
Synergy
Information
Abnormal Returns to
Merging Firms
Abnormal Returns to
Rival Firms
Positive
(Monopoly Rents)
Positive
(Monopoly Rents)
Positive
(Monopoly Rents)
Negative
(Costs of Price War)
Positive
(Cost Savings)
Positive
(Ident. of Underval. Resources)
Negative
(Competitive Disadvantage)
Zero or Positive
(Underval. Resources)
B. Probability Decreasing Events: Antitrust Complaint or Progovernment Decision
Theory Predicting the
Source of Merger Gains
Market Power:
Collusion, Cournot Model
Predatory Pricing Model
Economic Efficiency
Synergy
Information
Abnormal Returns to
Merging Firms
Abnormal Returns to
Rival Firms
Negative
(Loss of Monopoly Rents)
Negative
(Loss of Monopoly Rents)
Negative
(Loss of Monopoly Rents)
Positive
(Avioding Price War)
Negative
(Loss of Cost Savings)
Zero
Positive
(Avoid Comp.Disadvantage)
Zero
George Mason University School of Law
Law & Economics Center
Office Superstore Stock Prices
35
30
25
Y-Axis
20
15
10
5
0
-383
0
DATE RELATIVE TO ANNOUNCEMENT
OMX
SPLS
ODP
‡ Looking at merging firms stock price reactions does not yield useful information -- you cannot
differentiate between the Market Power and Economic Efficiency hypotheses.
‡ /RRNLQJDWWKHULYDOILUPV¶VWRFNSULFHUHDFWLRQVFDQGLIIHUHQWLDWHEHWZHHQ0DUNHW3RZHUDQG
Economic Efficiency hypotheses. However, it cannot differentiate between Efficiency and Predation
(the same issue the Court faced in Matsushita).
George Mason University School of Law
Law & Economics Center
List of Events
INDEX
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
LIST OF EVENTS
BEGINNING OF ESTIMATION PERIOD
END OF ESTIMATION PERIOD
MERGER ANNOUNCEMENT DATE
OMX ANNOUNCES EXPANSION PLAN
FTC STAFF SEEKS MORE DATA
SPLS POSITIVE EARNINGS REPORT
FTC EXPRESSES CONCERNS
SPLS BEGINS ADV ERTISING CAMPAIGN
ODP EARNINGS FLAT
MEETING SCHEDULED AT FTC
SPLS EARNINGS POSITIVE
FTC VOTES 4-1 TO BLOCK MERGER
STORE SALES PACT REACHED WITH OMX
SPLS SHAREHOLDER MEETING POSPONED
OMX SIGNS AGREEMENT TO BUY 63 STORES
FTC STAFF SPLIT
FTC REJECTS PROPOSED SPINOFF
SPLS TO CONTEST FTC
FTC FILES SUIT
SPLS SAYS PI WOULD END MERGER
PI HEARING SCHEDULED 5/19
ACQUISITION COSTS LOWERS SPLS ENGS.
PI HEARING BEGINS
REPORT ON PI HEARING
PI HEARING ENDS
SPLS/ODP AMEND PACT TO ALLOW TERMINATION
SPLS/ODP SHAREHOLDERS CLEAR MERGER
JUDGE GRANTS PI TO FTC AFTER MARKETS CLOSE
FIRST TRADING DAY AFTER COURT DECISION
SPLS DROPS MERGER PLAN
George Mason University School of Law
Law & Economics Center
Office Superstore Stock Prices
30
25
3
12
13 15 17
16
5
23
28
7
20
Y-Axis
15
10
5
0
-20
-10
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
DATE RELATIVE TO ANNOUNCEMENT
OMX
SPLS
ODP
(3) Office Max - Fell 62.5 cents on day of announcement (9/4/96).
(12) Rose 25 Cents on Day FTC voted 4-1 to Block Merger (3/11/97).
(13) Rose $1.75 on day agreement to purchase stores from mergered entity was reached ((3/13)
(17) Fell $1.125 on day FTC rejected settlement, unchanged when District Court granted PI.
Must look at price patterns in the large.
Also must consider abnormal returns, not prices or returns
George Mason University School of Law
Law & Economics Center
Theory & Empirical Estimation
C apital Asset Pricing Model:
Stocks are held in the market portfolio.
Unsystematic risk is diversified away through the holding of many stocks
Only systematic, or market risk is priced.
The return of a stock is linear in Beta:
r i = r f + (rm - r f)
= (Cov(r i , rm))/Var(rm)
T he Mar ket Model
The CAPM can be rewritten as
r i = (1- )r f + rm
Which can be estimated using the following market model
r i = a + brm +
where a equals (1- )rf, b equals , and is an error term.
George Mason University School of Law
Law & Economics Center
Estimating the Market Model
George Mason University School of Law
Law & Economics Center
OMX & S&P 500
OMX AND S&P500
DAYS -170 TO -21
0.150000
0.100000
OMX RETURN
0.050000
ACTUAL
0.000000
-0.050000
-0.100000
-0.150000
-0.1500000
-0.1000000
-0.0500000
0.0000000
0.0500000
0.1000000
0.1500000
S&P 500 RETURN
George Mason University School of Law
Law & Economics Center
Abnormal Returns
OFFICE MAX RETURNS
DAY - 20 T0 +186
0.150000
OMX RETURNS
0.100000
0.050000
0.000000
-0.050000
-0.100000
-0.150000
-20
-10
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
DAY RELATIVE TO ANNOUNCEMENT
ACTUAL
PREDICTED
George Mason University School of Law
Law & Economics Center
Office Max Abnormal Returns
DAY - 20 T0 +186
0.200000
0.150000
OMX RETURNS
0.100000
0.050000
0.000000
-0.050000
-0.100000
-0.150000
-20
-10
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
DAY RELATIVE TO ANNOUNCEMENT
ABNORMAL RETURNS
George Mason University School of Law
Law & Economics Center
OMX Cumulative Resdiuals
The cumulative abnormal return sums the abnormal return over time.
CR =
e it
DAY - 20 T0 +186
0.100000
0.000000
-0.100000
3
OMX RETURNS
-0.200000
5
13
-0.300000
16
7
-0.400000
23
15
17
12
-0.500000
-0.600000
-0.700000
-20
-10
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
160
170
180
DAY RELATIVE TO ANNOUNCEMENT
OMX CR
George Mason University School of Law
Law & Economics Center