Basic Business Law (BPP432/80) 2006 Fall Quarter Instructor: David Oliveiri Week 1: What is Law? Effective Decision-Making in a Legal Environment?

Agenda  Review Syllabus and Success Strategies The Big Picture The Big Picture What is Law? What is Law? What Law Applies? What Law Applies? The Lawmaking Process The Lawmaking Process Managerial Implications Managerial Implications Summary; Q&A Summary; Q&A

Syllabus Review – Goals Spot Issues Among Complex Commercial Facts Identify Pertinent Areas of Law That Impact Business Goals, Results Clear Thought/Statement/Concision to Define Risks, Compliance Costs, “Bargain-Arounds,” Opportunities

The Intersection of Law & Business Yahoo! is an internet service provider with a principal place of business in Santa Clara, California. Its American website, targets US users and provides many services including auction sites, message boards, and chat rooms, for which Yahoo! users supply much of the content. Nazi discussions have occurred in Yahoo!’s chat rooms and Nazi-related paraphernalia have appeared for sale on its auction website.

The Intersection of Law & Business Section R645-2 of the French Criminal Code bans exhibition of Nazi propaganda for sale and prohibits French citizens from purchasing or possessing such material. Although a Yahoo! Subsidiary, Yahoo! France, operates in France and removes all Nazi material from its site to comport with French law, French users can still access the American Yahoo! Website that carries Nazi- related discussions and auction items.

The Intersection of Law & Business In April 2000, LICRA and UEJF (two French associations) discovered that they could access in France and view Nazi materials. On May 22, 2000 a French court, at the request of LICRA and UEJF, issued an order requiring Yahoo!—subject to a fine of 100,000 Francs (approximately $13,300) per day—to prohibit access to Nazi artifacts on its site and to warn that viewing such material violates French law.

How Does This Situation Affect Yahoo? Status Quo — Prior to French Litigation Status Quo — Prior to French Litigation No Care “Yahoo”Care No Care “Yahoo”Care No Care -100,0 -100,-10 No Care -100,0 -100,-10 “French Public” Care -110,0 -20,-10 Care -110,0 -20,-10 No Cooperation Cost of Care (i.e., Filtering Content) = 10 Cost of “Injury” = 100 Probability of Injury Given 2-Party Care = 10%

Effect of French Court’s Holding New Status Quo – Imposition of a Rule New Status Quo – Imposition of a Rule No Care “Yahoo”Care No Care “Yahoo”Care No Care -100,0 -100,-10 No Care -100,0 -100,-10 “French Public” Care -10, ,-10 Care -10, ,-10 Results:1. Shifts Costs 2. Influences Future Behavior 3. Barrier to Entry?

Learnings Understand What Law Is/ Where It Comes From Understand What Particular Laws Apply to Transactions/ Business Activities Understand Nature and Role of Lawmaking Understand Why Law is Important to Business Managers Understand How Business Managers Make Effective Business Decisions in a Legal Environment

Some Perspective: A Big Picture Business Environment Technology Computers Telecommunications Production Methods Markets Competitors Customers Supplies Regulation Taxes Antitrust International Business Strategy Asset Structure Customer base Nature of knowledge creation Organizational Architecture Decision-right assignment Reward system Performance-evaluation system Incentives and Actions Firm Value

What Isn’t Law? Morals? Wall Street Journal 5/16/06 – “Bausch & Lomb issued a worldwide recall of its ReNu with MoistureLoc contact-lens solution and acknowledged that the solution may increase the risk of serious eye infections.” Annual MoistureLoc Sales = $100 Million; Recall Cost = $50-75 Million; Potential Product Liability = $500 -1,000 Million Ethics? The “Complication” of Stakeholders Wall Street Journal 5/16/06 – “…the company’s stock rallied [up 13%], reflecting investors’ confidence that its explanation would put the matter to rest, and that other Bausch solutions may not have the same problem.”.

Law and Morals “Thou Shalt Not Kill” “You must drive On the right side Of the road” “You should not Silently stand by and Watch a blind man Walk off a cliff” Source: Smith and Roberson’s Business Law, Mann & Roberts (Thomson/Southwestern, 13 th Ed. 2006)

Stakeholder Model of Business Corporation Managers Managers Employee s Community Stockholders Stockholders Suppliers Suppliers Customers Customers Source: Smith and Roberson’s Business Law, Mann & Roberts (Thomson/Southwestern, 13th Ed. 2006)

What is Law/Who Makes Law? Constitution The US Constitution imposes limits on the way managers can do business in the US? [Art I, Sec. 8-”Congress shall have power …To regulate Commerce with foreign Nations, and among several states…] Legislation/Statutes (Administrative Agencies/ Regulations) – New York’s Legal Drinking Age – Securities Act of ’34 -- SEC -- Regs

What is Law/Who Makes Law? Court Decisions –Precedent/”Stare Decisis” or “Let the Decision Stand” –A lower court in a state must always follow the decisions of a higher state court in its jurisdiction? –A California Supreme Court decision must be followed by a trial-level court in Las Vegas? –Common Law “Database” – An 1864 decision by a court on a particular matter is still good law?

What is Law/Who Makes Law? Private Models (Uniform Commercial Code, Other Uniform Laws) International Legal Context Common Law – UK, Australia, Canada, US Code-Based Systems – Western Europe; Roman Influences Socialist Systems – Russia, Eastern Europe Religion-Based Systems – Middle East

What Law Applies to a Particular Situation? Two Simon alums, who live in Texas and Virginia respectively, meet for a drink in New York City while on business trips. Over drinks, they agree to partner in an enterprise to place Internet kiosks in a string of California coffee houses. Each agrees to invest $35,000. They write a contract on a cocktail napkin and both sign it. Subsequently, one of the alums refuses to make the agreed investment and proceed with the deal. Two Simon alums, who live in Texas and Virginia respectively, meet for a drink in New York City while on business trips. Over drinks, they agree to partner in an enterprise to place Internet kiosks in a string of California coffee houses. Each agrees to invest $35,000. They write a contract on a cocktail napkin and both sign it. Subsequently, one of the alums refuses to make the agreed investment and proceed with the deal. What Law Applies? C, S, R, D of United States, Texas, Virginia, New York, and/or California? What Law Applies = f (Place, Type of Conduct, Hierarchy, Intent?) When Does This Even Matter?

What Law Applies? Geographic Sources of Law (C, S, R, D) – United States

A Court Won’t Entertain Dispute Unless It Has … Jurisdiction Jurisdiction PartiesSubject Matter In rem Personal Quasi in rem State Concurrent Federal Source: Smith and Roberson’s Business Law, Mann & Roberts (Thomson/Southwestern, 13th Ed. 2006)

Subject Matter Jurisdiction – The Types of Disputes Particular Courts Can Entertain Exclusive Federal Jurisdiction 1.Federal crimes 2.Bankruptcy 3.Patents 4.Copyright and trademarks 5.Admiralty 6.Antitrust 7.Suits against the United States 8.Specified Federal statutes Concurrent Jurisdiction 1.Federal questions 2.Diversity of Citizenship Exclusive State Jurisdiction; Everything Else Federal Matters Source: Smith and Roberson’s Business Law, Mann & Roberts (Thomson/Southwestern, 13th Ed. 2006)

Role of Lawsuits (Or Threat of Lawsuits) = Mechanism to Apply Law = f (Jurisdiction, C>S>R>D, Interpretation, Validity) Adjudicate Disputes Confer Rights Enforce Rights

Mechanisms of Legal System— Lawsuits and Lawmaking Judicial Lawmaking : Lawsuits = Disputes, Disputes = Facts + Law Stages - Summons/Complaint, Answer, Discovery, Motions, Pretrial Conference, Trial, Appeal Written Opinions of Court = Common Law Decision “Philosophies” of Judges -- Rights-Based Justice, Distributive Justice, Economic Efficiency Non-Judicial Lawmaking = Statutes, Regulations, To Address “Public” Issues Supply = Politicians and Political Process Demand = Special Interests END RESULT: LAW

Why is Law and Lawmaking Important to Business Managers? Legal Rules Define Enforceable Rights for Deal- Making, Conduct of Business –Legal Rules Minimize Information Costs! –Legal Rules Minimize Transaction Costs! –And …”Inefficient” Legal Rules May Provide a Predictable “Starting Point for Bargains” Law Impacts Enterprise Value –Threats of VIOXX, Bausch & Lomb MoistureLoc Lawsuits? –EEOC, EPA, SEC Investigations? –The role of Due Diligence and Purchase Agreement Warranties and Representations in Corporate Mergers and Acquisitions Criminal Liability

Managerial Analysis of Legal Issues “Legal Issues” = Disputes, Transactions, Activities Litigation Example: Decisions to Sue –Expected Value Test (Positive Expected Value => Sue; Negative Expected Value => Do Not Sue) –EV = NPV Recovery – NPV Cost –EV = f (timing, probabilities, cash flows); In US, Each Party Pays Their Own Costs! –Impact of Asymmetric or Complete Information

But Only A Very Small Percentage of Cases Go To Trial!

Managerial Analysis of Legal Issues Litigation Example: Decisions to Settle Once Again, Expected Value Test But … No Positive Expected Value Choice, Generally; So, Minimize Expected Loss => Settle When Expected Value of Settlement is Greater Than Expected Value of Defending Lawsuit! Game Theory Issue: Would You Ever Settle a Frivolous Lawsuit? Suppose it costs a disreputable customer of your business $500 to file a frivolous lawsuit that seeks $50,000 in damages, and it costs you $1000 to employ a lawyer and respond to the complaint by formal answer or motion. Suppose further that if you ignore the lawsuit and do not respond you will suffer a default judgment in the amount of $50,000! Would you be willing to settle even though you know that the suit is frivolous and that the plaintiff will drop the suit if you make a formal response? Does your business strategy (and answer) change if all of your customers have complete information?

Advanced Applications Decision Trees You have just received a letter from customer’s lawyer, threatening to sue your company for a million dollars in damages resulting from the malfunction of your company’s product. You are trying to decide whether to defend the lawsuit vigorously or settle. The customer’s lawyer has offered to settle for $600,000 if you accept this offer within 48 hours. After that, there will be no further settlement discussion. You learn from your lawyer that it would cost $100,000 to defend this action thru trial and that you have a 30% chance of winning (i.e. avoiding liability). On the other hand, there is a 50% chance that a jury will award the plaintiff a million dollars in damages, and a 20% chance that you will convince a jury that you are responsible for no more than $300,000 in damages. Should you settle or go to trial, assuming there are no game theory issues with settlement?

Decision Trees Litigate: Trial Cost-$100k Settle; -$600k Win (+$0); 30% chance Lose Big (-$1,000k); 50% chance Lose Small (-$300k); 20% chance Note: The probabilities of all uncertain outcomes must Add up to 100%

Decision Trees Litigate: Trial Cost-$100k Settle; -$600k Win; $0 EV Lose Big; -$500k EV Lose Small; -$60k EV Note: To calculate Expected Values, work backward (right-to left) in a decision tree -$660 EV -$600 EV

Advanced Application: Game Theory Thelma and Louise are executives of Endrun Corp. They have been involved in a pattern of securities laws violations for some time. Today, both Thelma and Louise have been arrested on warrants obtained by the local federal prosecutor. They are being held in separate cells, and are not allowed to communicate with each other. The federal prosecutor meets with Thelma and Louise separately and makes the following offer to each of them: Thelma and Louise are executives of Endrun Corp. They have been involved in a pattern of securities laws violations for some time. Today, both Thelma and Louise have been arrested on warrants obtained by the local federal prosecutor. They are being held in separate cells, and are not allowed to communicate with each other. The federal prosecutor meets with Thelma and Louise separately and makes the following offer to each of them: –“Confess and Cooperate with us! If your testimony helps us convict your partner in crime and get a 10 year sentence for her, we will recommend a one year sentence for you.” – “We will offer the same deal to your partner! If you don’t confess, and your partner testifies against you and helps us get a conviction, you’ll get 10 years.” –“If you and your partner both confess, the best I can do is get you a 5 year sentence.” Thelma and Louise are unable to communicate with each other. But they know that if neither of them decides to help the federal prosecutor, it is likely that they will be convicted of a lesser crime and get 3 year sentences. What will Thelma and Louise do? Thelma and Louise are unable to communicate with each other. But they know that if neither of them decides to help the federal prosecutor, it is likely that they will be convicted of a lesser crime and get 3 year sentences. What will Thelma and Louise do?

Advanced Application: Game Theory Thelma’s Choices ConfessSilence Confess Silence Louise’s Choices 5, 5 1, 10 10, 13, 3

Summary/Q & A Law and Lawmaking are Important to Business Law and Lawmaking Affect Business Rights, Behavior, and Value “Law” Comes From Multiple Sources – A Vast Matrix (50 states, 13 Federal Circuits, ? Countries) Law and Ethics Are Not The Same Thing; But Each Affect Business Value Law, Lawsuits (Actual or Potential), and Lawmaking Help Businesses Order Affairs Business Managers Use Specific Tools to Make Decisions in a Legal Environment Yahoo ?