Keep charity charitable

Texas Law Review

Volumn 88, Issue 6, 2010, Pages 1213-1233

  Galle, Brian ^a  

^a GEORGE WASHINGTON UNIVERSITY   (United States)

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EID: 78649245793     PISSN: 00404411     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (147)

1. E.g., Todd Henderson & Anup Malani, Corporate Philanthropy and the Market for Altruism, 109 COLUM. L. REV. 571, 576 (2009);
2. Anup Malani & Eric A. Posner, The Case for For-Profit Charities, 93 VA. L. REV. 2017, 2019-23 (2007).
3. Malani & Posner, supra note 1, at 2019-23.
4. Id. at 2019-21. For other recent (and largely positive) discussions of the noncharitable-charity model, see DAN PALLOTTA, UNCHARITABLE: HOW RESTRAINTS ON NONPROFITS UNDERMINE THEIR POTENTIAL 17, 116-25 (2008);
5. Dana Brakman Reiser, For-Profit Philanthropy, 77 FORDHAM L. REV. 2437, 2438 (2009);
6. James J. Fishman, Wrong Way Corrigan and Recent Developments in the Nonprofit Landscape: A Need for New Legal Approaches, 76 FORDHAM L. REV. 567, 598 (2007);
7. Victor Fleischer, Urban Entrepreneurship and the Promise of For-Profit Philanthropy, 30 W. NEW ENG. L. REV. 93, 93 (2007);
8. And Shruti Rana, From Making Money Without Doing Evil to Doing Good Without Handouts: The Google.org Experiment in Philanthropy, 3 J. BUS. & TECH. L. 87, 89 (2008).
9. The debate is long-standing in the hospital field. See, e.g., M. Gregg Bloche, Corporate Takeover of Teaching Hospitals, 65 S. CAL. L. REV. 1035, 1092 (1992) (arguing that for-profit hospitals can exist side-by-side with nonprofits).
10. Also related is the rise of collaborations between nonprofits and for-profit firms; for a survey, see MARTHA MINOW, PARTNERS, NOT RIVALS: PRIVATIZATION AND THE PUBLIC GOOD 7-22 (2002).
11. Additionally, while this Article was in press, Jim Hines, Jill Horwitz, and Austin Nichols provided the author with a copy of their own take on for-profit charity. James R. Hines, Jr. et al., The Attack on Nonprofit Status: A Charitable Assessment, 108 MICH. L. REV. 1179 (2010). Their approach is similarly critical of Malani and Posner, but largely for different reasons than those I outline here. See id. at 1207-18 (arguing that nonprofits have some incentives to be cost-effective and possess tools to encourage employees to do so; that nonprofits do not necessarily overproduce; and that allowing for-profit charities could allow tax arbitrage).
12. Malani & Posner, supra note 1, at 2029-56. The nondistribution constraint is a scholarly term for the prohibition on the distribution of a firm's net revenue to any person or entity. See infra notes 17-22 and accompanying text. All 501(c)(3)-eligible firms must abide by the nondistribution constraint. 26 U.S.C. § 501(c)(3) (2006). This means they cannot issue stock or pay their top-tier managers with a share of the firm's revenues.
13. See, e.g., Fishman, supra note 3, at 598 (celebrating the emergence of for-profit charities as an "encouraging development"); Brakman Reiser, supra note 3, at 2438 (arguing that for-profit charity challenges the assumptions of current charity law).
14. See, e.g., Rana, supra note 3, at 89 (suggesting that Google.org "must develop innovative accountability structures to match its ambitious goals"); Dana Brakman Reiser, Charity Law's Essentials 34-40 (Brooklyn Law Sch. Legal Studies Paper No. 167, 2009), available at http://papers.ssrn.com/ sol3/papers.cfm?abstract-id=1479572 (advocating group governance to reduce risks in for-profit charities).
15. See, e.g., John D. Columbo, The Marketing of Philanthropy and the Charitable Contributions Deduction: Integrating Theories for the Deduction and Tax Exemption, 36 WAKE FOREST L. REV. 657, 698 (2001) (contending that one should view the charitable-contribution deduction as a subsidy remedying a private market failure);
16. Mark P. Gergen, The Case for a Charitable Contributions Deduction, 74 VA. L. REV. 1393, 1394 (1988) (accepting that one can justify the charitable-contributions deduction as a subsidy);
17. Henry Hansmann, The Rationale for Exempting Nonprofit Organizations from Corporate Income Taxation, 91 YALE L.J. 54, 68, 71 (1981) (explaining that one can justify a charitable-contribution deduction because it stimulates production of an otherwise scarce good);
18. David E. Pozen, Remapping the Charitable Deduction, 39 CONN. L. REV. 531, 547 (2006) (stating that modern scholars have justified charitable-contribution deductions as a matter of public policy as a public subsidy);
19. Daniel Shaviro, Assessing the "Contract Failure" Explanation for Nonprofit Organizations and Their Tax-Exempt Status, 41 N.Y.L. SCH. L. REV. 1001, 1007 (1997) (reviewing the basic argument that the charitable- contributions deduction encourages the production of a public good);
20. See also OFFICE OF MGMT. & BUDGET, EXECUTIVE OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES: BUDGET OF THE UNITED STATES GOVERNMENT FISCAL YEAR 2008, at 257-59 (2007), available at http://www.gpoaccess.gov/usbudget/fy08/pdf/ spec.pdf (arguing that the federal government should provide tax incentives for charitable giving).
21. On the general theory of public goods, see RICHARD A. MUSGRAVE & PEGGY B. MUSGRAVE, PUBLIC FINANCE IN THEORY AND PRACTICE 42-48 (5th ed. 1989).
22. Id. at 44-45; see also Gergen, supra note 7, at 1397-98 ("Left to its own devices without a tax subsidy, [private charity] may not be able to overcome its freerider problems to provide the appropriate amount of the good."); Hansmann, supra note 7, at 72 (arguing that without incentives charitable contributions to nonprofits are below socially optimal levels).
23. MUSGRAVE & MUSGRAVE, supra note 8, at 44.
24. Hansmann, supra note 7, at 72.
25. See, e.g., JONATHAN GRUBER, PUBLIC FINANCE AND PUBLIC POLICY 184-85 (2d ed. 2006) (explaining that a fireworks display is a public good because it can be shared by many consumers and it is difficult to exclude consumers from the display).
26. Although I refer throughout this Article to "public goods," the reader should understand that the discussion for the most part also applies more generally to any private good with a significant positive externality attached. See id. at 171 ("It is helpful to think about a public good as one with a large positive externality."); MUSGRAVE & MUSGRAVE, supra note 8, at 49-50 (noting that the two are largely equivalent, albeit that a smaller subsidy is needed to produce private goods with positive externalities).
27. Similarly, in some cases, some of what I refer to as public goods might more precisely be described as "club goods" because in theory they could be "fenced" and made accessible only to "members." Again, some club goods may also produce externalities for nonmembers, such as an exclusive park with historic social significance. Here, again, there will be underprovision of the nonprivate aspects of consumption; the club will not necessarily use the park in a way that is consistent with historic preservation. For a survey of other arguments for government production of potential club goods, see Amnon Lehavi, Property Rights and Local Public Goods: Toward a Better Future for Urban Communities, 36 URB. LAW. 1, 16-24 (2004).
28. See BRUCE R. HOPKINS, THE LAW OF TAX-EXEMPT ORGANIZATIONS § 4.10, at 103-08 (9th ed. 2007) (explaining that the IRS may deny eligibility on the basis that an "organization's operation is similar to a commercial enterprise operated for profit" and providing examples).
29. See 26 U.S.C. §§ 4941-4942, 4958 (2006) (authorizing the IRS to revoke exemptions); IRS, PUB. NO. 4221-PC, COMPLIANCE GUIDE FOR 501(C)(3) PUBLIC CHARITIES 2-3 (2009), available at http://www.irs.gov/pub/irs-pdf/ p4221pc.pdf (outlining IRS enforcement procedures for charitable entities).
30. See Henry B. Hansmann, Reforming Nonprofit Corporation Law, 129 U. PA. L. REV. 497, 623 (1981) (arguing that government subsidy to charitable organizations justifies federal oversight of nonprofit status);
31. See also Rob Atkinson, Altruism in Nonprofit Organizations, 31 B.C. L. REV. 501, 617-18 (1990) (explaining that under Hansmann's analysis "only nonprofit firms address the kinds of contract failure and experience the kinds of capital constraints that warrant" a subsidy).
32. Hansmann, supra note 16, at 501; Henry B. Hansmann, The Role of Nonprofit Enterprise, 89 YALE L.J. 835, 838 (1980).
33. Hansmann, supra note 16, at 506; see also Atkinson, supra note 16, at 572 (arguing that managers of a for-profit firm would need to provide an "altruistic investor" with an enforceable commitment "that they will use the imputed return on her donated capital to subsidize consumption").
34. Hansmann, supra note 7, at 68-70; cf. Kenneth J. Arrow, Uncertainty and the Welfare Economics of Medical Care, 53 AM. ECON. REV. 941, 964-65 (1963) (suggesting that the profit-making aspect of hospitals is relatively unimportant because doctors' commitment to professionalism helps to assure patients unable to measure quality that the doctors will prioritize care over profits).
35. Hansmann, supra note 7, at 69-70.
36. Id. at 69; Hansmann, supra note 16, at 506-07.
37. Hansmann, supra note 16, at 507; Malani & Posner, supra note 1, at 2033-34; see also Susan Rose-Ackerman, Altruism, Nonprofits, and Economic Theory, 34 J. ECON. LIT. 701, 716 (1996) ("[D]onors may be willing to donate only to nonprofit institutions. Given the difficulty of monitoring charitable work, donors may fear that for-profit firms will convert gifts into profits for the owners.").
38. See John D. Donahue, Market-Based Governance and the Architecture of Accountability, in MARKET-BASED GOVERNANCE 1, 5-6 (John D. Donahue & Joseph S. Nye, Jr. eds., 2002) (describing the difficulties of arriving at universal definitions of success in areas of public interest, such as schools and taxes).
39. Hansmann, supra note 17, at 846-47.
40. GRUBER, supra note 12, at 287-89.
41. Malani & Posner, supra note 1, at 2035.
42. Id. at 2035-36.
43. Id. at 2036; see also Michael Krashinsky, Transaction Costs and a Theory of the Nonprofit Organization, in THE ECONOMICS OF NONPROFIT INSTITUTIONS: STUDIES IN STRUCTURE AND POLICY 114, 117 (Susan Rose-Ackerman ed., 1986) (suggesting that warranties and middlemen are alternatives to the nondistribution constraint);
44. Geoffrey A. Manne, Agency Costs and the Oversight of Charitable Organizations, 1999 WIS. L. REV. 227, 229 (offering "creation of private, for-profit monitoring companies" as a solution to failures in nonprofit monitoring).
45. Malani & Posner, supra note 1, at 2036.
46. Id. at 2037-38.
47. Id. at 2038.
48. Cf. Atkinson, supra note 16, at 519 (observing that enforcing the nondistribution constraint is costly for monitors). At the state level, attorneys general are the main enforcers of nonprofit firm charters. See James J. Fishman, Improving Charitable Accountability, 62 MD. L. REV. 218, 259-65 (2003) (tracing the past and present role of attorneys general in enforcing accountability in the nonprofit sector).
49. To the extent that the burden of higher monitoring costs is borne by the recipients of charity, such as through lower total expenditures, this shift in distribution might be the equivalent of a regressive tax. That is, if beneficiaries are poorer on average than the average taxpayer, the shift in incidence redirects wealth from poor to rich. In most economic analysis, that shift would reduce overall social welfare because of the diminishing marginal utility of wealth: money is more valuable to those who have less of it. MUSGRAVE & MUSGRAVE, supra note 7, at 83-85.
50. Brian Galle, The Role of Charity in a Federal System 77 (Dec. 1, 2009) (unpublished manuscript), available at http://papers.ssrn.com/sol3/papers.cfm? abstract-id=1473107. Making the consumption of public goods more costly through charity would also make lobbying for government provision relatively more attractive, which is a poor outcome if we think that charity is justified as a cure for some of the problems of public choice theory. Id. at 27-33.
51. Malani & Posner, supra note 1, at 2052-53.
52. Id. at 2052-54.
53. See David M. Schizer, Subsidizing Charitable Contributions: Incentives, Information and the Private Pursuit of Public Goals, 62 TAX L. REV. 221, 254 (2009) (advocating subsidizing "for-profit" charities only if the definition of eligible activities is tightened considerably);
54. Victor Fleischer, "For Profit Charity": Not Quite Ready for Prime Time, 93 VA. L. REV. IN BRIEF 231, 231-32 (2008), http://www. virginialawreview.org/inbrief/2008/01/21/fleischer.pdf (noting that if the nondistribution constraint were removed, the broad language of § 501(c)(3) would open the floodgates for companies to claim to be charities).
55. See HOPKINS, supra note 14, § 8.5, at 292 (describing rules under which entities can qualify for 501(c)(3) status through their "advancement of education or science").
56. It is useful to distinguish the deduction the firm takes for its own costs from the deduction outsiders could receive for purchasing charitable services from the firm. The firm itself can always take a deduction for its ordinary and necessary expenses. See Fleischer, supra note 37, at 232-33 (pointing out that a corporation may use the losses from an unprofitable subsidiary - such as a charity - to offset the taxable income of a profitable subsidiary). So the key issue here is really whether the firm's "customers" can take a deduction.
57. See Brakman Reiser, supra note 3, at 2466 (acknowledging this concern about for-profit charities); Hines et al., supra note 3, at 1212 (making this point with regard to donor efforts to monitor firms); Schizer, supra note 37, at 255 n.82 ("[T]ransfer pricing is already quite malleable, and without separate legal entities it becomes even harder to monitor.").
58. See Atkinson, supra note 16, at 570 (describing the cost-lowering benefits of horizontally and vertically integrating for-profit and nonprofit organizations).
59. For a sense of the difficulties here, consider the law of joint ventures between nonprofit and for-profit hospitals, which covers more than one-hundred pages in a leading treatise. MICHAEL I. SANDERS, JOINT VENTURES INVOLVING TAX-EXEMPT ORGANIZATIONS 491-609 (3d ed. 2007).
60. Cf. Hansmann, supra note 17, at 883 (noting that the deduction "gives a financial advantage to [firms] that qualify for it"). This is already a serious problem with many current collaborations between nonprofits and for-profits, as with hospitals and affiliated for-profit care centers owned by physicians who practice at the hospital. The doctors can refer patients from the hospital to their own businesses, in effect leveraging the good will and contacts of the hospital to their own gain. Council on Ethical & Judicial Affairs, Am. Med. Ass'n, Conflicts of Interest: Physician Ownership of Medical Facilities, 267 J. AM. MED. ASS'N 2366, 2366 (1992).
61. Henderson & Malani, supra note 1, at 590-93.
62. Malani & Posner, supra note 1, at 2048-50; see also Myron J. Roomkin & Burton A. Weisbrod, Managerial Compensation and Incentives in For-Profit and Nonprofit Hospitals, 15 J.L. ECON. & ORG. 750, 752-53 (1999) (noting that nonprofits may pay higher base salaries than for-profits to compensate for the lack of profit-based compensation).
63. Malani & Posner, supra note 1, at 2034-35; see also Marco A. Castaneda et al., Competition, Contractibility, and the Market for Donors to Nonprofits, 24 J.L. ECON. & ORG. 215, 222 (2007) (discussing the ways that promotional expenditures by nonprofits may provide utility to donors and asserting that increased promotional expenditures lead to increased donations);
64. Richard A. Posner, What Do Judges and Justices Maximize? (The Same Thing Everybody Else Does), 3 SUP. CT. ECON. REV. 1, 8-9 (1993) (positing that people who choose to work in the nonprofit sector may willingly trade income for increased job security or other sources of nonmonetary utility).
65. Malani & Posner, supra note 1, at 2054-56.
66. Henderson & Malani, supra note 1, at 598-600. Henderson and Malani also offer other similar arguments that warrant less discussion. For example, they suggest that for-profit firms acquire unique "leverage" over charities' managers by collating many different donations. Id. at 599. In the charitable literature, this is a function commonly attributed to foundations. See Atkinson, supra note 16, at 583-84 (arguing that sizable private foundations may have adequate leverage to achieve economical deals with for-profit suppliers that smaller donors could not). They also point to the greater societal scrutiny of for-profit firms generally. Henderson & Malani, supra note 1, at 599-600. But they offer no reason to suspect that this scrutiny is aimed at the philanthropic activities of firms-as opposed to, say, the other, vastly larger, activities of the firm. Cf. id. at 622 (noting that the average firm contributes 1.5% of profits to charity).
67. See B. Douglas Bernheim & Antonio Rangel, Behavioral Public Economics: Welfare and Policy Analysis with Nonstandard Decision-Makers, in BEHAVIORAL ECONOMICS AND ITS APPLICATIONS 7, 62-65 (Peter Diamond & Hannu Vartiainen eds., 2007) (evaluating the difficulty of quantifying the effects of warm glow); Rose-Ackerman, supra note 22, at 712-13 (observing that donors may donate in order to feel a warm glow that is separate from and in excess of their desire that others benefit from their contribution).
68. See James Andreoni, Impure Altruism and Donations to Public Goods: A Theory of Warm-Glow Giving, 100 ECON. J. 464, 473-74 (1990) (predicting that, all other things being equal, donors prefer a transfer of income that will result in the most warm glow);
69. Kenneth J. Arrow, Gifts and Exchanges, 1 PHIL. & PUB. AFF. 343, 348-49 (1972) (describing blood donors as being partially motivated by the moral satisfaction gleaned from having individually contributed to the welfare of society);
70. Bernheim & Rangel, supra note 49, at 62-65 (providing a partial list of "warm-glow mechanisms," including responses to perceived public perception of the donor's behavior and positive and negative reciprocity); Peter Diamond, Optimal Tax Treatment of Private Contributions for Public Goods with and Without Warm Glow Preferences, 90 J. PUB. ECON. 897, 917 (2006) (arguing that warm glow is partially a result of the decrease in social pressure to donate);
71. Amihai Glazer & Kai A. Konrad, A Signaling Explanation for Charity, 86 AM. ECON. REV. 1019, 1019-21 (1996) (presenting evidence for the proposition that altruism is often motivated by a desire to demonstrate wealth); Rose-Ackerman, supra note 22, at 712-13 (pointing out that the satisfaction people derive from philanthropy stems from both seeing positive changes in the community and from the warm glow associated with giving).
72. See, e.g., Bruce R. Kingma & Robert McClelland, Public Radio Stations Are Really, Really Not Public Goods: Charitable Contributions and Impure Altruism, 66 ANNALS PUB. & COOP. ECON. 65, 66-67 (1995) (citing studies showing that impure altruism, including warm glow, explains some charitable giving);
73. John Peloza & Piers Steel, The Price Elasticities of Charitable Contributions: A Meta-analysis, 24 J. PUB. POL'Y & MKTG. 260, 265 & tbl.1 (2005) (compiling studies and concluding that tax deductions are treasury efficient, suggesting that noneconomic motivations are involved in charitable giving).
74. See Bruce R. Kingma, Public Good Theories of the Non-profit Sector: Weisbrod Revisited, 82 VOLUNTAS 135, 142 (1997) (arguing that employee control over the organization's mission and services explains empirical evidence of lower wages in the nonprofit sector);
75. Roomkin & Weisbrod, supra note 45, at 753-54 (noting studies finding higher wages in for-profits but suggesting explanations other than a warm glow offset in complex industries); Shaviro, supra note 7, at 1003 (suggesting that certain fields are more likely to benefit from warm glow in the potential labor pool). Professor Malani has acknowledged this possibility in his other work. See Henderson & Malani, supra note 1, at 583-84, 619 (acknowledging that workers would be likely to accept lower wages in exchange for jobs that provide warm glow).
76. See Malani & Posner, supra note 1, at 2047-48 ("[A]ltruists obtain additional value from producing public goods ⋯.").
77. See Glazer & Konrad, supra note 50, at 1020-21 (explaining that donors donate to charity at least partly for signaling purposes rather than simply to obtain satisfaction unrelated to status).
78. See WILLIAM J. BAUMOL ET AL., CONTESTABLE MARKETS AND THE THEORY OF INDUSTRY STRUCTURE 192 (1988) (asserting that monopoly rents permit new entrants).
79. Nonprofit entrepreneurs would not enter a field simply to leverage submarket wages into profits because by definition they cannot extract profit. Thus, it is more likely that nonprofit entrepreneurs launch their endeavors to meet unmet social needs or to find employment, and accordingly they would not be attracted by low wages.
80. Malani & Posner, supra note 1, at 2055-56. Empirical evidence also suggests that competition for donor funds at least partially disciplines nonprofit firms. See Castaneda et al., supra note 46, at 245 (concluding that competition, along with contracting, reduces reported administrative expenses).
81. See Krashinsky, supra note 28, at 117; Rose-Ackerman, supra note 22, at 719 (arguing that ideological commitment plays an important role in overcoming inefficient incentives within professions); George G. Triantis, Organizations as Internal Capital Markets: The Legal Boundaries of Firms, Collateral, and Trusts in Commercial and Charitable Enterprises, 117 HARV. L. REV. 1102, 1147 (2004) (asserting that informational asymmetry between donors and managers creates an obstacle in fundraising situations). On the other hand, prestige motivations introduce another possible agency cost, as Triantis argues. Id. at 1116-17.
82. See Kingma, supra note 52, at 142 (opining that employees and entrepreneurs in nonprofits prefer serving the public good to increased wages and social output); Rose-Ackerman, supra note 22, at 719 (noting that ideologue founders seek employees that share their ideals and vision). But see Linda Sugin, Resisting the Corporatization of Nonprofit Governance: Transforming Obedience into Fidelity, 76 FORDHAM L. REV. 893, 907 (2007) (noting that low pay may also simply attract those who are less skilled). I assume, in contrast to Professor Sugin's view, that firms can screen for employee quality. Whether there are likely to be sufficient numbers of skilled employees is a subject I return to shortly.
83. It could be argued that some individuals will also choose nonprofit employment as a way to gain leisure time in exchange for a lower salary. For that to be true, the employee would have to expect that the firm's principals are unable to monitor her effectively. That is plausible. See Hansmann, supra note 16, at 507, 568 (observing that patrons of nonprofits have little authority to oversee the management and work of the nonprofit). On the other hand, coworkers can monitor their fellow employees' efforts more easily. See Hansmann, supra note 17, at 876 (remarking that normative constraints operate better in certain nonprofits than in others). If coworkers are motivated by their mission or resent slacking in others, this monitoring may have some bite. Cf. Mark Barenberg, Democracy and Domination in the Law of Workplace Cooperation: From Bureaucratic to Flexible Production, 94 COLUM. L. REV. 753, 881-903 (1994) (describing self-monitoring workplaces). As a result, it would seem that those who value leisure above salary could obtain the same tradeoff between salary and leisure without the risk of sanction simply by taking a part-time job.
84. See Hansmann, supra note 17, at 876 (noting that nonprofits are likely to choose as managers those whose ideals match the firm's).
85. The argument here is similar to, but distinct from, Bruno Frey's point that extrinsic motivations may sometimes "crowd out" people's internal motivations to do good. Bruno Frey, A Constitution for Knaves Crowds Out Civic Virtues, 107 ECON. J. 1043, 1044-47 (1997). Like Frey, I argue that an inaptly designed subsidy may actually reduce incentives to engage in the subsidized behavior, but the mechanism I suggest is not the same as the psychological factors he surveys, id. at 1045-46.
86. See Glazer & Konrad, supra note 50, at 1020-21 (stating that, according to empirical data, donations serve as a means to signal income to those who do not view the individual's consumption of luxury goods).
87. See Malani & Posner, supra note 1, at 2065 (suggesting that the IRS should permit nonprofit managers to receive incentive pay correlated to profits, revenues, or the operating costs of the organizations).
88. Cf. Hansmann, supra note 16, at 524 (suggesting that changed norms in some parts of the nonprofit sector could "undermine the collective morality of that sector as a whole").
89. Malani & Posner, supra note 1, at 2047-49.
90. Hines, Horwitz, and Nichols argue that nonprofits can probably lawfully offer their employees performance incentives. Hines et al., supra note 3, at 1193-97. They acknowledge, though, that there is no clear guidance on the question, id., and that anecdotal evidence suggests most firms are unwilling to push to find the edge of the legal limits, id. at 1196-97. Also, there is little even in their careful unpacking of the applicable law to suggest that firms can pay managers for cutting costs, which I will argue here are the most problematic incentives (and the incentives of greatest interest to Malani and Posner). In any event, my analysis suggests that any strong expansion towards permitting powerful incentives in nonprofit compensation would be a mistake.
91. See Lucian Arye Bebchuk et al., Managerial Power and Rent Extraction in the Design of Executive Compensation, 69 U. CHI. L. REV. 751, 761-63 (2002);
92. Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. FIN. ECON. 305, 328 (1976) (both discussing use of employee compensation structures as tools for controlling employee incentives).
93. See Bebchuk et al., supra note 67, at 775 (describing stock options as a crucial means of encouraging executives to maximize firm performance and shareholder value); David Weisbach, Tax Expenditures, Principal-Agent Problems, and Redundancy, 84 WASH. U. L. REV. 1823, 1846-47 (2006) (discussing how assigning risk from the principal to the agent can alter agents' incentives).
94. See Weisbach, supra note 68, at 1846-48 (asserting that without large cash incentives, incentives given to public servants are considered low-powered and thus less effective).
95. See, e.g., Armen A. Alchian & Reuben A. Kessel, Competition, Monopoly, and the Pursuit of Money, in ASPECTS OF LABOR ECONOMICS 157, 166 (Nat'l Bureau of Econ. Research ed., 1962) (noting that a public utility does not possess the ability to distribute wealth as dividends to its owners and thus can only offer weak incentives).
96. See EDWARD E. LAWLER III, STRATEGIC PAY 58 (1990) (stating that when used incorrectly, incentive systems enable many employees to spend their energies outsmarting the system rather than increasing the value of the products); Triantis, supra note 58, at 1114 (explaining that shifting risk to managers may increase risk-averse decision making, resulting in inefficient allocation of capital).
97. See, e.g., John C. Coffee, Jr. & Hillary A. Sale, Redesigning the SEC: Does the Treasury Have a Better Idea?, 95 VA. L. REV. 707, 729-30 (2009) (explaining that because of the transition in compensation from cash to stock options, senior management undertook riskier strategies);
98. Jeff N. Gordon, "Say on Pay": Cautionary Notes on the U.K. Experience and the Case for Shareholder Opt-In, 46 HARV. J. ON LEGIS. 323, 363-64 (2009) (remarking that the compensation structures of senior executives that were based on high-powered incentives enabled excessive risk taking).
99. This is not to say that managerial incentives were nearly the whole story. See, e.g., INT'L MONETARY FUND, GLOBAL FINANCIAL STABILITY REPORT: FINANCIAL STRESS AND DELEVERAGING 14 (2008), available at http://www.imf.org/ external/pubs/ft/gfsr/2008/02/pdf/text.pdf (pointing to the U.S. housing market); Coffee & Sale, supra note 72, at 731-49 (exploring regulatory failure, the structure of the investment-banking industry, moral hazard by mortgage originators, and behavior by bank executives as contributing possibilities).
100. See George P. Baker, Incentive Contracts and Performance Measurement, 100 J. POL. ECON. 598, 599-600, 606 (1992) (asserting that if the agent's actions do not directly conform to the principal's objectives, there will inevitably be inefficiencies).
101. E.g., Hansmann, supra note 17, at 898 n.160; Manne, supra note 28, at 239; Posner, supra note 46, at 10; Triantis, supra note 58, at 1147; see also William W. Bratton & Joseph A. McCahery, The New Economics of Jurisdictional Competition: Devolutionary Federalism in a Second-Best World, 86 GEO. L.J. 201, 236 (1997) (arguing that the evaluation problem prevents meaningful interjurisdictional competition based on quality of outputs).
102. Brian A. Jacob & Steven D. Levitt, Rotten Apples: An Investigation of the Prevalence and Predictors of Teacher Cheating, 118 Q.J. ECON. 843, 844 (2003). Similarly, an earlier study of educational incentives found that measuring student outputs led to "cream skimming": more aggressive recruitment of students who would score high on the evaluation tool without any additional schooling, greatly reducing the usefulness of the money spent on training.
103. Michael Cragg, Performance Incentives in the Public Sector: Evidence from the Job Training Partnership Act, 13 J.L. ECON. & ORG. 147, 161-62 (1997).
104. Daron Acemoglu et al., Incentives in Markets, Firms, and Governments, 24 J.L. ECON. & ORG. 273, 274 (2008);
105. See also Oliver E. Williamson, Public and Private Bureaucracies: A Transaction Cost Economics Perspective, 15 J.L. ECON. & ORG. 306, 325 (1999) ("[A]dded incentive intensity undermines probity.").
106. David Weisbach offers a related point, building on Holmstrom and Milgrom and others. Weisbach points out that if some but not all of an agent's outputs can be measured and the agent is offered high-powered incentives, the agent will tend to overproduce the measurable outputs. Weisbach, supra note 68, at 1848-49 (citing AVINASH K. DIXIT, THE MAKING OF ECONOMIC POLICY 96 (1996); Bengt Holmstrom & Paul Milgrom, Multitask Principal - Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design, 7 J.L. ECON. & ORG. 24 (1991)).
107. See Hines et al., supra note 3, at 1197-98, 1205-06 (arguing that difficulty of measuring nonprofit outputs can make it hard to design incentives for managers and might allow them to cut costs at expense of quality); Jill R. Horwitz, Why We Need the Independent Sector: The Behavior, Law, and Ethics of Not-for-Profit Hospitals, 50 UCLA L. REV. 1345, 1410 (2003) (arguing that low-powered incentives are key to ensuring that nonprofits deliver high-quality services);
108. cf. Jonathan R. Macey, Transaction Costs and the Normative Elements of the Public Choice Model: An Application to Constitutional Theory, 74 VA. L. REV. 417, 491-93 (1988) (claiming that public officials cannot be controlled adequately by standard incentive-based pay because there exist no useful measures on which to base the incentives). This point is also consistent with the familiar claim in the incentives literature that the usefulness of incentives as a monitoring tool declines with the ease of measuring performance accurately. Baker, supra note 74, at 609-11.
109. "Privatization" refers to the shift of government activities to the private - usually the private for-profit - sector. MINOW, supra note 3, at 1-3.
110. See, e.g., id. at 64-65 (asserting that schooling systems governed by a privatized, incentive-based model do not take into account the fact that education is not about academic achievement alone but also involves the transmission of civic ideals to students so that they can become "productive workers and responsible citizens," and thus education "has crucial features that depart from privately consumed goods and services"); John D. Donahue, The Transformation of Government Work: Causes, Consequences, and Distortions, in GOVERNMENT BY CONTRACT: OUTSOURCING AND AMERICAN DEMOCRACY 41, 43-45 (Jody Freeman & Martha L. Minow eds., 2009) (claiming that shifting production of services to for-profit firms leads to cost-cutting as "the prime directive");
111. Oliver D. Hart et al., The Proper Scope of Government: Theory and an Application to Prisons, 112 Q.J. ECON. 1127, 1136-41 (1997) (arguing that private ownership leads to a strong incentive to strive for cost reduction and a weak incentive to engage in quality improvement).
112. E.g., Karen N. Eggleston & Richard J. Zeckhauser, Government Contracting for Health Care, in MARKET-BASED GOVERNANCE, supra note 23, at 29, 42-43, 55-56; Hart et al., supra note 80, at 1141-43, 1154-55.
113. See JOEL L. FLEISHMAN, THE FOUNDATION: A GREAT AMERICAN SECRET 22-24 (2007) (warning that tax exemptions for donations must be available to a broad array of organizations, or else unpopular entities would not receive support);
114. Boris Bittker & George Rahdert, The Exemption of Nonprofit Organizations from Federal Income Taxation, 85 YALE L.J. 299, 342 (1976) (explaining that tax-exempt organizations "enjoy the privilege of spending 'government money'" to further their independent objectives while being protected from legislative pressure regarding this spending).
115. See Atkinson, supra note 16, at 636-37 (warning that one of the risks of basing the tax exemption of charities on altruism theory is that "only certain favored purposes [will] be allowed to thrive"); Dean Pappas, Note, The Independent Sector and the Tax Law: Defining Charity in an Ideal Democracy, 64 S. CAL. L. REV. 461, 476 (1991) (acknowledging that the IRS's use of a single, broad criterion of "charitable" - that an organization "serve the public and not significantly contravene public policy" - may produce a conformist view of "charitable");
116. See also NORMAN I. SILBER, A CORPORATE FORM OF FREEDOM: THE EMERGENCE OF THE NONPROFIT SECTOR 5-6, 31-66 (2001) (tracing the history of the judicial evaluation of charity in an effort to show that judicial decisions reflect the judiciary's policy preferences).
117. It is worth emphasizing that I believe such governance innovations are possible. See Galle, supra note 34, at 80 (suggesting that organizations "should be obliged to explain why their organization deserves a subsidy, taking into account opportunity costs, moral hazard, and other possible harms to others" and that "[t]reasury officials should be empowered to consider these arguments and reject the application of organizations that lack merit, albeit while subject to careful oversight by layers of administrative and judicial review").
118. See Steven L. Schwarcz, Systemic Risk, 97 GEO. L.J. 193, 198 (2008) ("[N]o individual market participant has sufficient incentive ⋯ to limit its risk taking in order to reduce the systemic danger to other participants and third parties.").
119. See Pappas, supra note 83, at 476 (noting the potential for charitable organizations to use the benefits of tax exemption "to contravene public policy and create injustice").
120. See MUSGRAVE & MUSGRAVE, supra note 8, at 190-91 (summarizing empirical findings that social insurance crowds out work).
121. Gordon, supra note 72, at 364-66; see also Schwarcz, supra note 85, at 206 (noting that firms are motivated to protect themselves, not the system as a whole).
122. Henderson & Malani, supra note 1, at 598-600.
123. Cf. Bloche, supra note 3, at 1096-97; Eggleston & Zeckhauser, supra note 81, at 45 (both noting that, under competition from for-profit hospitals, nonprofits begin to behave like for-profits).
124. See RICHARD POSNER, ECONOMIC ANALYSIS OF LAW 455 (7th ed. 2007) (claiming that "corporations avoid controversial charities" because of potential adverse reactions from shareholders).
125. Cf. Sharon Dolovich, How Privatization Thinks: The Case of Prisons, in GOVERNMENT BY CONTRACT: OUTSOURCING AND AMERICAN DEMOCRACY, supra note 80, at 128, 134-35 (claiming that private firms will not account for values that are incommensurable with cost savings); Rose-Ackerman, supra note 22, at 721 (suggesting that peaceful coexistence between for-profit investor interests and existence of the nondistribution constraint would be "fragile" because of "short-term opportunism"); Williamson, supra note 77, at 331-32 (arguing that private firms cannot duplicate bureaucratic performance because of tensions between profit motive and public mission).
126. See Archon Fung, Making Social Markets: Dispersed Governance and Corporate Accountability, in MARKET-BASED GOVERNANCE, supra note 23, at 145, 155 (arguing that consumers have difficulty selecting products based on social preferences because there are few resources that facilitate the play of social values in economic markets).
127. Malani & Posner, supra note 1, at 2050. Among those who advance this argument are John Donahue and Martha Minow. See JOHN DONAHUE, THE PRIVATIZATION DECISION: PUBLIC ENDS, PRIVATE MEANS 33-34 (1991) (noting the tendencies of different individuals to be informed about different topics and the overall impact this has on dividing public business between the public and private sectors); MINOW, supra note 3, at 34 ("It is too often empirically false to assume the existence of sufficiently informed consumers.").
128. See Malani & Posner, supra note 1, at 2050-51 (arguing that some donors are unable to correctly choose between charities and, therefore, governments must be aware of this when directing or matching subsidies and donations).
129. Id. at 2050.
130. Id. at 2051.
131. Id.
132. Id. at 2051-52.
133. See, e.g., Angela Littwin, Beyond Usury: A Study of Credit-Card Use and Preference Among Low-Income Consumers, 86 TEXAS L. REV. 451, 499 (2006) (suggesting that consumers are unlikely to understand common credit-card contract terms);
134. Ronald J. Mann, "Contracting" for Credit, 104 MICH. L. REV. 899, 911 (2006) (positing that consumers are unlikely to look at credit-card contracts and consequently do not rationally consider credit-card contract terms).
135. See, e.g., Oren Bar-Gill, Seduction by Plastic, 98 NW. U. L. REV. 1373, 1378 (2004) (arguing that additional disclosure requirements should be implemented to protect consumers from excessive credit-card interest rates).
136. Cf. Oren Bar-Gill et al., Product Use Information and the Limits of Voluntary Disclosure 3-4 (2009) (unpublished manuscript, on file with Texas Law Review) (arguing that some forms of mandatory disclosure may not be useful to consumers because consumers themselves have "imperfect information about how they will use a product").
137. Henderson & Malani, supra note 1, at 575.
138. See Deborah A. DeMott, Self-Dealing Transactions in Nonprofit Corporations, 59 BROOK. L. REV. 131, 134, 146-47 (1993) (highlighting the different standards imposed on nonprofit self-dealing and explaining why such externalities likely exist); Fishman, supra note 3, at 576 (noting that self-dealing and other civil and criminal wrongdoings by charitable fiduciaries have led to regulatory, legislative, public, and media scrutiny of the nonprofit sector).
139. Cf. Dan M. Kahan, Trust, Collective Action, and Law, 81 B.U. L. Rev. 333, 334-35 (2001) (arguing that conspicuous rewards and punishments can create the perception that the regulated individuals are not inclined to comply voluntarily). This point is controversial.
140. See, e.g., Leandra Lederman, The Interplay Between Norms and Enforcement in Tax Compliance, 64 OHIO ST. L.J. 1453, 1484-99 (2003) (arguing that the evidence is inconsistent with Kahan's hypothesis).
141. Malani & Posner, supra note 1, at 2051.
142. See MANCUR OLSON, THE LOGIC OF COLLECTIVE ACTION: PUBLIC GOODS AND THE THEORY OF GROUPS 145 (1971) (noting that trade associations are one tool for overcoming the political free-rider problem). Trade associations are the groups that produced, for example, the "Got Milk?" and "Pork: The Other White Meat" campaigns.
143. Jon D. Hanson & Douglas A. Kysar, Taking Behavioralism Seriously: A Response to Market Manipulation, 6 ROGER WILLIAMS U. L. REV. 259, 363 (2000).
144. See Atkinson, supra note 16, at 636-37 (cautioning that government oversight may restrict charity only to "favored purposes").
145. See Galle, supra note 34, at 52-78 (outlining the six goals).
146. Id. at 77.
147. See HOPKINS, supra note 14, §§ 20.1-27.17 (outlining limits on nonprofit activities and tools for government oversight of them).