Submitting Merger Lawyers to the Market Test

Matt Levine shall supply the problem:

The way merger lawsuits work is that after a deal is signed, a bunch of plaintiffs’ lawyers race to sue, claiming that the merger was underpriced, the board breached its fiduciary duties, and the whole thing was corrupt. This might sometimes be true, but it can’t be true in every merger, and the lawyers sue in virtually every merger. But then they sign a settlement with the company in which the company agrees to make a few extra disclosures about the deal and pay the lawyers a six-figure fee. The advantage for the company and the board is that the settlement binds all shareholders, so they get a release from future litigation if someone figures out that the deal was actually corrupt. The advantage for the lawyers is that they get the fee. There is no advantage for shareholders.

We shall provide the solution:

Do not pay the lawyers a cash fee.

At a random time, while the market is open, announce the disclosures that will be provided.

Then, pay the lawyers a fee proportionate to the stock’s movement (relative to the overall market) over the next hour (or second, or day, or week).

If the disclosure they heroically provided to shareholders is valuable, they will be rewarded.

But, if the disclosure they provided was a disappointment to the market, they have to pay the company. (And the court).

This system is both fair and efficient. Fair, because the lawyers will be paid if they added value to the company, and punished if they subtracted value. Efficient, because this will encourage them to only pursue lawsuits they think will add value.

Now, the lawyers (and perhaps my readers) will object that news of these disclosures would be but one small thing effecting the price of the stock that day. There would be a lot of noise – how then can it be fair to use such an unreliable method to reward the noble public servants who forced the disclosures?

And other lawyers (and perhaps other readers) will object that this could be manipulated. The lawyers could short the stock in to the announcement, and then cover their shorts when the news broke, and buy a lot of stock instead, to try to temporarily support the stock.

Fortunately, both issues can be solved together. Because this is not a single game, it is a repeated game. Any one time the lawyers might get unlucky and have the stock move “the wrong way”. But if done often enough (and this is their profession) they will come out ahead… if the disclosures they achieve are valuable. And maybe they could manipulate the stock once. But if they try to do it systematically, hedge funds will learn off it and take the opportunity to buy the stock when it is inefficiently cheap before the announcement… and then short it when the lawyers temporarily drive it up. The lawyers would need to burn a huge amount of money to manipulate the stock in the face of hedgies after an easy trade… at which point the whole thing would no longer be net profitable for them.

Does this sound plausible to you? It should, if they are adding value. If they’re on the side of angels, they should leap at the chance to have their worth measured.

Of course, this is rather a stretch. I suspect that if this were implemented, lawyers would cease these lawsuits.

And that would be good.

GiveWell is not an Index Fund.

Someone¹ on facebook recently asked

Can we think of donating to GiveWell- or GWWC-recommended charities as being the philanthropic analogue of investing in an index fund? In the sense that it may be possible in principle to do better, but it’s close to the best among readily available options, and almost everybody who tries to do better will do worse.

I think this analogy overlooks some important points about the underlying structure.

An Index contains all the stocks that satisfy some very broad criteria – for example, the S&P500 is basically “is very large US company”. Index funds invest in all the stocks in a specific index.² Index funds try to do as well as the index on the whole – no better, no worse.

Active managers, on the other hand, by small subsets of the stocks in the index, and try to beat the index. That is, they try to buy stocks that will do better than the average stock in the index.

Part of the appeal of index funds is that many people think that all stocks have basically equally good prospects, ex ante, due to the Efficient Market Hypothesis.There are good reasons to think that free markets are in general very efficient.

Givewell looks at a large number of charities, and selects a very small number to recommend. In this way they’re much more like an active manager than an index fund. An index fund for charities would mean spreading out your donations between thousands of different charities.

There are important differences between the stock market and the charity market. Virtually any time you think you see an inefficiency in the stock market, you are probably wrong. But this does not apply to the charity market. Effective Altruists habitually and credibly claim that there are many orders of magnitude difference between the expected values of different charities (pdf). And the sorts of arguments about risk and diversification that motivate balanced portfolios of investments simply do not apply to charities; with charities, you should pick the best one and donate everything to it.³

Some perhaps Index Funds are Givewell are similar insomuchas they are both good things. But so is chocolate.

This analogy glosses over important differences, and potentially causes sloppy thinking. Just because two things are good doesn’t mean they are good for the same reasons or in the same way. Effective altruists would do well to understand that markets are not like charities. Others would do well to understand the there is no Efficient Charity Hypothesis!

---

1. who will remain anonymous until they request otherwise. ↩
2. technically some merely invest in representative sub-baskets, but S&P500 indexes probably buy all the constituents. ↩
3. unless you are very rich. ↩