Strategic Responses to Disclosure Information
One of the oddities about franchise disclosure laws is this: more disclosure law produces less actual due diligence. This is of course not the intended consequence.
First, let's review the case against the current disclosure laws regarding the sale of franchises, business opportunities and income earning opportunities.
According to the economic theories which our consumer protection laws are built upon, a more knowledgeable consumer will be better protected from fraud. Fraud is a defect in information.
Thus, for purchasers of business opportunities, franchises, and more passive investment vehicles we have disclosure laws which reverse the ordinary common law of "buyer beware". Now, it is "seller disclose".
Individuals who purchase these type of earnings opportunities are required by law to be provided with more information than the market would usually provide.
Yet, as I have consistently argued, with example after example, the underlying economic rationale does not work for the sale of franchises and business opportunities.
It may not work for the sale of investments either.
Disclosure doesn't work, not because people are stupid, lazy or dumb. Individuals react in a predictable way to information that is contrary to their prior commitments: they discount it dramatically.
Requiring the seller to provide better information, but only seven or ten days before the actual purchase, which contradicts or conflicts with the purchaser's pre-disclosure evaluation of the company will at best be downgraded and ignored, and at worst, propel the individual to make exactly the wrong decision, faster and quicker.
Part of the solution to this problem is to require that the disclosure documents for franchises, business opportunities, and network marketing opportunities be made public so that individuals could review them prior to contacting the company or opportunity.
Another part of the solution is to allow private individuals to prosecute violations of the FTC Rule.
But this assumes that cognitive dissonance is the only problem to be solved. Is it?
Now, let's look at another question: Are there other situations in which disclosure, designed to remedy or balance the "buyer beware" motif of the marketplace, simply does not do its job?
Well, the laws dealing with conflict of interest require disclosure -on the theory that any conflict of interest will be sanitized by that disclosure.
But, in a very interesting article, titled "The Dirt on Coming Clean: The Perverse Effects of Disclosing Conflicts of Interest", Daylain M. Cain, George Lowenstein, and Don A. Moore, have designed an experiment which shows disclosing conflicts of interests can actually make the situation even worse!
Robin Hanson, at Overcoming Bias, describes the experiment on conflict of interest.
"In the first condition, in which the advisers did not disclose their conflict of interest, they knowingly gave misleading advice. In the experiment, the clients lost money because they followed the advisers' suggestions.In the second condition, the advisers disclosed their conflict of interest: they conceded they would benefit if the clients heeded the advice. But coming clean didn't have the expected result.
Although the clients, now aware that their advisers were biased, were more skeptical about taking the advice, "they didn't discount it enough," said George Loewenstein, a professor of economics and psychology at Carnegie Mellon University and a co-author of the study, which was conducted at the university.
And the advisers, still determined to make more money, exaggerated their claims. "The advisers ended up making even more money than in the first condition, which is exactly the opposite of what you would hope for or expect," he said."
Why should this be? First, the individuals who get the disclosure tend not to discount their advisor's information enough - even thought they "know" that their advisor has a different agenda.
Second, the advisor's who disclose their conflict of interest tend to give even more biased information, incorrectly believing that their advice might be severely discounted.
The authors conclude that instead of disclosing the conflict of interest, the advisors should simply not be allowed to act in way which engages the conflict.
There is at least one US Court which agrees with authors.
Consider this example from tort law and bundled settlements. Bundling settlements is a way of dealing with a group's claim to tort damages without focussing too specifically on the individual merits.
As such, the plaintiffs' lawyer is conflict with individuals who have very good cases because the lawyer also represents the individuals who have worse cases.
Can the lawyer simply escape this conflict by disclosing it to the clients?
As described by Walter Olson at the Point of Law blog, this is an inherent conflict, which cannot sanitized by a disclosure statement.
"A distinctive danger of "bundled" settlements, or "batch" or "inventory" settlements as I have called them on another occasion, is that plaintiff's lawyers may refuse to settle a relatively strong case unless a defendant also agrees to settle many relatively weak cases. In the batch settlement the defendant winds up paying more money, but since it also winds up spreading around that money among many claimants, the "strong" individual claimant (say, one with mesothelioma who worked closely with the defendant's product) may fare less well than if his case had been taken to settlement on its own.At the same time, it would seem plausible that rightly employed, batch settlements can serve legitimate objectives of economy, finality and closure; some defendants might prefer or even instigate them, while conscientious plaintiff's lawyers might take care to manage the process so that no clients were shortchanged.
Perhaps the Michigan court's action reflects a prudential estimation that in the asbestos case, these potential advantages are outweighed by the risks of abuse."(my emphasis)
My hope is that we obtain more experimental evidence about what we can reasonably expect from a consumer/investor/franchisee protection disclosure regime, in contrast to what the thin theory of rational expectations assumes we will get.
We might even find experimental evidence showing that removing the FTC Seal and warning from the disclosure document increases effective due diligence.
