Putting Technology to Good Use: The Role of Corporate, Competition, and Tax Law

Innovation and its main output, technology, are changing the way we work, socialize, vote, and live. New technologies have improved our lives and made firms more productive, raising living standards across the world. Thanks to progress in information technology, the rate of change is accelerating. Disruption and disequilibrium are now commonplace. Our recent paper, prepared for the first phase of the British Academy’s ‘The Future of the Corporation’ initiative and published in the Journal of the British Academy, reflects on the roles corporate, competition, and tax law (collectively “business law”) can play in simultaneously facilitating innovation, enhancing welfare, and assuaging emerging societal risks arising from new technologies.

In what follows we outline some of the key points discussed in the paper, in relation to two specific contexts: financing innovation-focused businesses and digitalization.

Financing Innovation-Focused Businesses

In our paper, we discuss the critical relationship between investment innovation and market dynamics. Ensuring ongoing investment in innovation requires a careful balancing of market dynamics, corporate incentives, and access to capital. Importantly, high mark-ups do not provide a guarantee for welfare-enhancing investment in innovation. To identify optimal regulatory structure and enforcement regimes, investment in innovation should be assessed alongside market concentration, barriers to entry, likely disruption, and other industry characteristics.

How does one optimize investment in R&D?

Raising outside financing for R&D faces multiple challenges. R&D generates assets that are incompletely protected (if at all) by property rights and cannot be appropriated. Furthermore, it produces opaque and highly volatile results. These challenges can be managed by outside investors that invest alongside technical-expert managers through, for example, venture capital funds, institutional investors with concentrated holdings, and public firms that have durable founder control (DFC). In addition, the positive externalities generated by R&D suggest a potential role for government policy to stimulate such activity through, for example, tax credits.

Of course, not all investment in R&D promotes consumer welfare, and the trend towards concentration in many key sectors of the economy can lead to welfare-decreasing innovation. For example, under limited competition, innovation may be used to increase product differentiation, reduce interoperability, and push out existing and potential competitors. Business law should be designed and enforced in a way that seeks to reduce firms’ incentive to engage in negative innovation while promoting (or at least not chilling) their incentive to invest in innovation that generally promotes overall welfare.

Digitalization in Business and Organizations

Digitalization offers many opportunities for business law. One example is the use of smart contracts. These have the potential to greatly reduce the costs of organizing business activities by contract. The resulting increase in substitutability between firms and contracts has significant implications for business law (and other regulatory regimes, including employment law), not least because of the arbitrage opportunities that might arise.

Alongside the opportunities, digitalization also presents new challenges and societal risks. For instance, new technology applied or produced by a firm may generate risks for other members of society that were not appreciated until the technology was deployed (“emergent risks”). A salient example is the revelation over the past couple of years of the impact of social media on the democratic process. The management of emergent social risks presents a challenge for regulation and corporate governance. The social costs of new technologies may be brought home to the firm through legal or reputational penalties, but those approaches will probably be only partially successful. Negligence-based liability, by definition, does not extend to emergent risks. Reputational sanctions also appear unlikely to lead to a full internalization of social costs. (Pre-emptive regulatory controls and strict liability might have more promise, but they have an adverse impact on incentives to innovate and significant practical limitations).

Another challenge concerns short-termism regarding corporate investments in compliance activities and systems. The starting point here is that low probability of public enforcement necessitates socially wasteful high penalties to produce the desired deterrent effect. Corporate compliance programs could reduce misconduct and the need for socially wasteful penalties. However, short-termism can lead to under-investment in such programs.

In our paper, we discuss several solutions to such challenges. Corporate managers’ incentives to invest corporate resources in compliance activities can be strengthened in a variety of ways that are likely to complement each other, including: lengthening the vesting period for managerial compensation, clawbacks, or personal liability, and mandating disclosure about compliance activities. Neutral policies vis-à-vis corporate ownership structures, possibly allowing for DFC mechanisms and favouring controllers’ commitment to their firms, may make it less likely that firms adopt a myopic attitude to emergent risks. Those risks can also be addressed through ‘forward compliance,’ meaning that firms’ compliance programs should be dynamic, focussing not only on what the applicable rules are at the time of any particular action, but also what they are likely to be in the future.

This section ends by noting that digitalization has also exacerbated long-standing problems of the international corporate tax system. Reform targeting certain highly digitalized business is being considered and even implemented by some countries, but comprehensive system-wide reform would appear preferable.

Business Law Reform and the Political Climate

Having discussed the ways in which business law can be molded to cope with the effects of accelerated innovation and the disruption it generates across society, the paper provides some reflections on two phenomena that are likely to have a significant impact on business law (and business law-making). The first is the rise of populism – fueled by technological change and globalization and affecting the left and the right wings of the political spectrum. The second is the likely persistence, whether in the new political environment or in liberal democracies, of businesses’ ability to effectively influence the political process, which digitalization makes even greater. These two phenomena do not warrant an optimistic assessment for society’s ability to engineer business law as a means of optimizing the challenges associated with innovation. For that very reason, though, it is essential to keep asking what a rational and evidence-based response to the current challenges should look like.

We set out a range of recommendations for further research in an appendix to the paper.

This post comes to us from professors John Armour, Luca Enriques, Ariel Ezrachi, and John Vella at the University of Oxford. It is based on their recent paper, “Putting Technology to Good Use for Society: The Role of Corporate, Competition and Tax Law,” available here. A version of the post appeared on the Oxford Business Law Blog.

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