Thursday, October 20, 2011

Limits of Law and Social Norms

Two in one day!

Even as a gosh-durn liberul, I recognize there are limits to what the law (or government) can accomplish. Because of the difficulties of writing and enforcing laws, there will always be some gap between what the legal system accomplishes and the socially optimal policy. One area where this is relatively clear, for instance, is executive compensation.

Scholars have studied the issue for decades and have yet to devise an efficient way to properly regulate the behavior of corporate executives within their firms. Collective-action problems and agency costs are well known. Solutions are more elusive.

Given the failure of internal corporate governance mechanisms, the government could take a more draconian approach, but I'm not sure how helpful this would be. You can set an executive compensation cap, but then people will classify themselves as non-executives. You can cap non-executive pay, but then people will call themselves consultants. And so on. That's not to say we shouldn't try to stop them from doing it by restructuring our legal system. But we should also recognize that there will always be an imperfect match between what is legal and what is good/moral/fair (whatever term you want to use).

Social norms, though, can fill a gap the law can't. They narrow the difference between people's actions and what we think is socially beneficial. Occupy Wall Street may never get any legislation passed, but they will make people think about these issues. Most people want to be liked--maybe shame will overcome their otherwise innate desire for greed. Perhaps executives will one day realize it's somewhat inappropriate to extract more and more for their own benefit while completely abdicating your responsibility to shareholders, employees, and society. Or, more generally, that just because no law stops you from doing something doesn't mean you should do it.

And maybe this can apply more broadly. Most "white-collar" criminals work within the system. They get lawyers to help them push their actions to the brink of the law. They get lobbyists to help them move the brink even further. It's difficult to make it illegal for them to change the law for their benefit, but perhaps it's possible to make it socially illegitimate (and perhaps economically harmful to them) to do so.

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