Law and Information

I just got back from a conference on “Legal Institutions and Entrepreneurship” at Stanford, organized by the Gruter Institute for Law and Behavioral Science and the Kauffman Foundation. Experts from various disciplines, including biology, neuro-economics, zoology, and business studies, among others, discussed the question how innovative entrepreneurship (in the Schumpeterian sense) can be facilitated by legal institutions and alternative institutional arrangements like, for instance, reputation systems.

In my contribution, I presented the idea of a “legal lab” analogous, for instance, to the MIT’s media lab, which would be devoted to the study of innovations within the legal/regulatory system itself and would experiment with innovative institutional regimes (e.g. using virtual worlds such as Second Life as rich social environments). Together with my St. Gallen collaborators Herbert Burkert and Patrick Gruendler as well as with my colleagues and friends at the Berkman Center, John Palfrey and Colin Maclay, I’ve been working on this idea for some months, and I’m thrilled that several conference participants – including Judith Donath and Oliver Goodenough – will help us to work towards a project proposal in the weeks to come.

In my formal presentation, I attempted to frame the main research topics at the heart of the law & entrepreneurship debate by offering an initial mental map, consisting of three related, but analytically distinct clusters of research.

1. The first cluster deals with a set of rather fundamental questions concerning the basic relationship between the legal system and entrepreneurship.

Traditionally – and in the US in particular – law has been perceived as a constraint on behavior. Entrepreneurs, in contrast, are in the rule-breaking business. Entrepreneurship is very much about creative anarchy, as Deborah Spar eloquently described it, and from this angle law is usually perceived as an obstacle to innovation and entrepreneurship. However, a number of scholars – most prominently Viktor Mayer-Schoenberger in a recent paper – have demonstrated that the relation and interaction between the legal system and entrepreneurship is more complex.

In my view, the relation is at least three-dimensional: (a) law can foster entrepreneurship innovation (e.g. by providing incentives for creativity = IPR), (b) it can be in a neutral relationship, or (c) may indeed hinder innovation (e.g. overly protective labor laws). Where law has a positive impact, it does so, as Mayer-Schoenberger argues, in its potential function as a leveler (e.g. lowering market entry barriers), protector (e.g. property rights, limitation of liability), or enforcer (esp. in case of contractual arrangements).

2. A second area of research seeks to gain a deeper, much more granular understanding of the interactions among the legal system, innovation, and entrepreneurship.

Within this cluster, one might roughly distinguish between two research initiatives: First, there are attempts aimed at exploring the various elements of the legal ecosystem and its impact on entrepreneurship. Such attempts need to be sensitive to varying contexts, sectors, and cultures (e.g. interplay among the elements is different in ICT market vs. biotech sector; or picture may look very different when it comes to low-income vs. high-income countries).

One example in this category is an earlier Berkman project on digital entrepreneurship that focused on low-income countries. Based on case studies of national innovation policies and successful entrepreneurial projects, we identified the relevant elements and aspects of the legal ecosystem and evaluate their influence on entrepreneurship. We clustered the elements in two basic categories: substantive areas of law and legal process issues. Our big-picture take-away: When it comes to the impact of law on entrepreneurship, much depends on the specific economic, societal, and cultural circumstances.

The second debate with this research cluster relates to the different approaches and regulatory techniques that can be used by law – and their promises and limits when it comes to entrepreneurship. This includes research on different types and forms of regulation, such as direct vs. indirect regulation (e.g. regulation of capital markets); framework regulation, self-regulation, incentive-based regulation, command-and-control, etc. Cross-sectional challenges that occur when law seeks to regulate innovation and entrepreneurial activities, too, fall into this category, including questions such as justification of legal intervention (e.g. fostering economic growth, encouraging spillover effects), prioritization (good legislation as a scarce resource!), timing, trade-offs (e.g. between innovation and risk prevention), how to ensure that the legal system can learn, etc.

3. The third cluster is less analytical and more design-oriented. Again, one can differentiate between two perspectives: One the one hand, how to optimize existing legal institutions to foster entrepreneurship. On the other hand, what are more radical innovations within the legal system itself aimed at facilitating innovative entrepreneurship?

As far as the first aspect – optimization or improvements – is concerned, a number of law reform projects on both sides of the Atlantic are illustrative, all of which claim to facilitate entrepreneurship. Currently, the probably hottest topic is the reform of the patent system in the U.S. Several tax reform projects in Europe are also linked to entrepreneurship. In corporate law, the creation of exemptions for smaller companies – aimed at reducing the regulatory burden, esp. in areas such as accounting and reporting obligations – are further examples.

But there’s a more fundamental design question lurking in the background: Are we working with the right assumptions when creating legal rules aimed at fostering entrepreneurship? Essentially, there are two black boxes when it comes to innovation and entrepreneurship:

(1) Regulators often have an over-simplified understanding of the creative processes that lead to innovation. The case in point is certainly the digitally networked economy, with the prominent phenomenon of collaborative creativity and the innovative potential of networks. Behavioral law & economics is in this context particularly important when we seek to understand the underlying mechanisms, and the findings have relevance for instance in the area of IPR systems (with its traditional single inventor/author paradigm, linear innovation as archetype), but also for corporate law (e.g. providing fora for new, highly dynamic, network-based forms of collaboration.)

(2) We don’t understand the entrepreneur’s calculus very well. Mayer-Schoenberger in the paper mentioned above has made this point: How important is predictability and legal certainty? How does risk evaluation really work in the case of innovative entreprneurs? How can law shape these processes? This research cluster is less about substantive areas of law rather than about key variables, such as “incentives”, “risks” and “flexibility”, which may be shaped by using different legal tools (ranging from safe harbor provisions to innovative licensing schemes).

4. Looking forward and in conclusion, I propose the building of an international network of researchers who work on the three clusters mentioned above. In a first step, it would be important to take stock and share existing findings based on which a shared research agenda can be developed.

From a legal/regulatory perspective, a research agenda could focus on three tasks and topics, respectively:

• First, drafting a number of case studies based on which the interactions between legal institutions and entrepreneurship can be studied in greater detail, across different setting and cultures. Macro-level case studies on national legislative programs and policies (e.g. Singapore, Hong Kong) would be supplemented by micro-level case studies about successful entrepreneurs and their projects/firms/etc.

• Based on this research, the research network could second work towards a theory of law, innovation, and entrepreneurship, which would include both normative and analytical/methodological components.

• Third, the research network could establish a “legal lab” that deals with innovation within the legal system itself (see above). Virtual worlds like SL could be used for experiments with alternative institutional designs and to measure their impact on innovation in complex environments.