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How Can Law Foster Innovative Entrepreneurship? A Blueprint for a Research Program


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.

Law, Behavior, and the Brain Conference


I’m currently on my way to far-away Olympic Valley, CA, where I have the great pleasure to attend the Gruter Institute for Law and Behavioral Research Conference on Law, Behavior, and the Brain. The conference, led by Monika Gruter Cheney, brings together a terrific interdisciplinary group of roughly 40 experts in areas such as evolutionary biology, neuroscience, behavioral economics, and – yes – also a number of legal scholars. During four days, we will be exploring topics such as “State of Play: Law, Behavioral Biology and Neuroscience,” “Rationality, Emotions and Moral Judgments in Humans and Other Species,” “Property and Economics,” and “Results in Neuroeconomics and Experimental Economics,” to list just a few sessions. I’m much looking forward to learning from all conference contributors, including Paul Zak, Carl Bergstrom, Kevin McCabe, John Clippinger, Bruce Hay, Oliver Goodenough, Susan Bandes, Larry Frolik, Sara Beale, Terry Maroney, among many others.

Here are the abstracts of my contributions to the conference:

1) Panel on Law & Emotions

A recent interdisciplinary conference in Switzerland was dedicated to law & emotion scholarship. In my brief presentation, I would like to answer the apparently trivial question asked by a conference participant: “Given the fact that it isn’t that much of a surprise that even judges, prosecutors, etc. have emotions, and that therefore emotions play a role in decision-making processes with legal relevance, what’s really the contribution of law & emotion research and scholarship? What’s new about it?”. I will try to answer this question in a systematic way, arguing that law & emotion research has (or might have) an impact on (at least) two levels, each consisting of two elements: the analytical level with the elements “phenomenon (stipulated facts)” and “legal actors”, and the design level with “norms applicable to the facts of the case” and “norms governing the production of law.” I will use a few stories – ranging from file-sharing to the U.S. Patriot Act – to illustrate these points.

2) Presentation on Digital Institutions / Social Signaling Theory

Social signals play an important role in defining social relations and structuring societies, both in the on- and offline world. In my presentation, I will focus on the role of social signaling in the digitally networked environment. More precisely, I will explore the promises and limitations of social signaling theory as applied to cyberspace, including digital institutions. In essence, I will address three questions: First, in what online contexts do we have an interest in signal reliability and honest signaling? Second, what are regulatory strategies and approaches (using Lessig’s framework of four modes of regulation) to increase the reliability of social signals? And third, who will make the decisions about the degrees of required signal reliability in cyberspace?

3) New Insights into Property Panel

My last year’s presentation focused on a new generation of neuro-science-informed arguments aimed at explaining large-scale file-sharing over P2P networks. This year, my contribution to the property panel will not focus on the explanation of a presumably illegal activity, but on a socially desirable one: In my talk entitled “Social economics of collaborative creativity”, I will provide a brief overview of the literature that seeks to explain why thousand of volunteers work together in lose-knit networks to peer-produce an online encyclopedia (Wikipedia), to come up with improved versions of an open-source web browser (e.g. Mozilla), or create shared open content platforms, to name just three examples. The presentation ends with the outline of a research agenda.

Promises and Limits of a Law and Economics Approach to IPR in Cyberage


Over the past few weeks, our graduate students at the Univ. of St. Gallen have done quite some heavy lifting in the three courses that I described here. In my own course on law and economics of intellectual property rights in the digital age, we’ve completed the second part of the course, which consisted of three modules dealing with digital copyright, software and biz methods patents, and trademarks/domain name disputes. We were very fortunate to have the support of three wonderful guest lecturers. Professor John Palfrey taught a terrific class on digital media law and policy (find here his debriefing and putting-into-context). Klaus Schubert, partner with WilmerHale, provided an excellent overview of the current state of software patenting in and across the EU, in the U.S., and Japan and made us think about the hard policy questions up for discussion. Last week, Professor Philippe Gillieron from the Univ. of Lausanne discussed with us the legal and economic aspects of domain name disputes and ways to solve them (the focus was on UDRP – in my view a particularly interesting topic when analyzed through the lens of new institutional economics theory, see also here for variations on this theme.)

In the last session before “flyout” week, Silke Ernst and I had a first cut at a synthesis aimed at tying together several of the core themes we’ve been discussing so far. At the core of the session was the question as to what extent the law & economics approach can help us to deal with the complex IPR-questions that are triggered while transitioning from an analog/offline to a digital/online information environment. The students contributed to the session by presenting their views on the promises of and limits on a law & economics approach to IPR in the digital age. Using the time while traveling from Oxford back to Zurich, my recollection of the in-class discussion looks as follows (alternative interpretations, of course, encouraged and welcome) – starting with the argument that the law & economics approach to IPR serves at least two functions:

  • On the one hand, it provides a toolset that helps us to frame, analyze, and evaluate some of the complex phenomena we observe in cyberspace (such as, for instance, large-scale file-sharing over P2P networks or the user-created content), and enables us to gain a better understanding of the interaction among existing rules and norms and these phenomena. We might want to call it the “analytical function” of law & economics (this aspect gets close to – but is in my view not exactly identical with – what has traditionally been described as the “positive” strand of discussion in law & economics.)
  • On the other hand, law & economics may guide us at the design level (again, this gets close to what has been termed “normative” law & economics. For reasons I don’t want to discuss here, I don’t want to work with this distinction in the present context.). First, it can help us to identify the need for law reform by showing that the existing rules have a negative impact on social welfare. Here, the design function intersects with the previously mentioned analytical function. Second, law & economics provides a consistent framework to evaluate the impact of alternative means of regulation on the (economic) behavior of individuals and compare costs and benefits of different approaches aimed at solving a particular problem.

At a more granular level, we might identify the following promises and limitations of a law & economics approach with regard to the respective functionality:
Analytical function

  • Promises: coherent framework, consistent and shared set of criteria, rational and quasi-objective analysis, …
  • Limitations: Bounded rationality/areas of non-rationale behavior, lack of transparency regarding underlying causalities, limited possibilities to quantify phenomena, lack of empirical data, …

Design function:

  • Promises: Cost-benefits analysis of alternative policy choices, taking into account perspectives of different actors in an ecosystem, at least ideal-type predictions based on models, …
  • Limitations: Complexity of real-life situations, non-economic perspectives, motives, and effects, non-economic values, …

We reached some sort of consensus that the law & economics approach indeed provides a great toolset to analyze at least some of the trickiest IPR-related policy questions in cyberspace. However, the large majority seemed also to agree that some of the limitations of such an analysis become particularly visible in the digitally networked environment with phenomena such as commons-based peer production of content based on intrinsic motivations. Most of us also agreed that it would be dangerous to attempt to answer the IPR policy questions only against the backdrop of law & economics theory. Indeed, many of the decisions to be made in this space ultimately include choices about core values of our society that do not easily translate into the frameworks of law & economics, like for example informational justice, equal access, participatory culture, or semiotic democracy.

I’m very much looking forward to continuing the discussion about the role of law and economics in the digital age with my colleagues, the teaching team, and – most importantly – with the wonderful group of students enrolled in this seminar.

Formation of Digital Institutions: Some Comments


I just returned from 02138, where I attended a working conference on digital institutions sponsored by the Berkman Center and the Gruter Institute and chaired by my colleagues Oliver Goodenough and John Clippinger. During two (rather intense) workshop days, an impressive line-up of panelists and discussants representing various backgrounds and areas of research – ranging from neuroeconomics, biology to virtual world developers – shared their knowledge about “digital institutions” with each other.

I was asked to frame the theme of a panel with Colin Maclay, Mike Best, and Iqbal Quadir on the formation of institutions in developed and developing economies. I started with a series of questions to be discussed and issues to be considered. First, I offered some thoughts about terminology and key distinctions that I considered being helpful for the discourse. Second, I briefly touched upon core elements that are likely to have an impact on the formation of digital institutions, emphasizing the importance of pre-existing institutional arrangements

Here are my notes:

1) Introducing basic distinctions: What do we mean by the term “institution”?

  • Reviewing the literature in fields of sociology, economics, and law, it’s far from clear what the term means and how it differs from related terms such as “organizations” or “firms”. Generally, definitions of institutions include at least two elements: (a) Institutions consist of a set of rules, plus (b) some sort enforcement regime.
  • Within this broad definition, however, various types of institutions can be distinguished, for example:
    • internal institutions = community enforcement of rules (e.g.: Wikipedia with neutrality of viewpoint rule; enforced through community/peers; P2P file-sharing with strong norms re: sharing [“charismatic code” – cf. Strahilevitz]).
    • external institutions = government enforcement of rules (e.g.: Intellectual property rights)
    • informal institutions = emerge without explicit agreements (e.g.: Blogger ethics, e.g. “Identify and link to sources whenever feasible.”)
    • formal institutions = based on deliberative formation processes (e.g.: ICANN)
  • Similarly, formation of institution varies:
    • spontaneous emergence (e.g.: online discussion groups)
    • authoritative formation (e.g.: Companies providing virtual world platforms are created by entrepreneurs (= authority))
  • Why do we (or should we) care about definitions?
    • Epistemological argument: The way we conceptualize “institutions” shapes the way we perceive (digital) institutions as subject of our research
    • To define means to differentiate: In order to deepen our understanding of formation of institution, we need some degree of granularity. Different types of institutions, e.g., emerge and evolve in different ways
    • Putting together various pieces of knowledge about formation of institutions from different areas of research in order to use it in context of digital institutions also requires a relatively fine-grained picture of the concept “institutions”.
  • However, traditional distinctions may not be 100% feasible for the digitally networked environment. Example: Virtual Worlds (such as Second Life) are at the same time…
    • …internal institutions (avatars create & enforce their own rules) and external institutions (e.g. Linden Lab using EULAs, IP law, etc.)
    • …informal institutions (rules of behavior within the game emerge in part w/out explicit agreements) and formal institution (e.g. enactment of “in world laws/codes in deliberative processes)
  • In fact, first research question as to what extent the distinctions of analog/offline world translate into digital/online world.
    • Possible starting point: Institutional approach to “commons-based peer production” of content (social production beyond hierarchies and price signals; cf. Benkler)
  • For this panel, we use a broad an open terminology; pragmatic approach. Digital institution here includes diverse online phenomena such as Wikipedia, Flickr, eBay, Second Life … but also offline institutions operating in digital environment (e.g. mobile phone networks)

2) Formation of digital institutions: What are important factors that shape the formation of digital institutions?

At least three interrelated and interacting, but analytically distinct elements:

  1. Preexisting institutional arrangements, both “analog” and “digital”
  2. Technology (availability, pricing, development, …); physical and logical layer
  3. Content-related aspect (content “supply” and “demand”; content diversity, quality, etc., but also human factor: ability to process information, knowledge, and entertainment, incl. level of education, literacy, etc.)

Focus on (1) = importance of preexisting institutional arrangements

  • Analog” institutions have huge impact on formation of digital institutions; analog and digital not clearly separable
    • Example 1: Legal system: Consider what is required to establish a Virtual World such as Second Life? [(1) establishing Linden Research Inc.; (2) creating platform – requires everything from corporate law over contract to IPR]
    • Example 2: Economic system: Consider the role of financial system, e.g. micro-credits in low-income countries; cf. Grameen village phones project
  • “Digital” institutional arrangements, too, have impact on formation of new digital institutions
    • Internet: Esp. digital institutions at logical layer of the Net for providing services at content layer (fundamental example: ICANN – domain name system)
    • Offline, but digital: phone networks (incl. mobile) and other infrastructure as prerequisite for digital entrepreneurs (here, intersection with second element: technological development)
  • These few remarks illustrate interdependency and complexity, both at theoretical and practical level. Now: digging deeper in a case-study mode (Iqbal, Mike, Colin) – as one way to deal with complexity.

So far my remarks. After sessions with formal presentations covering issues such as trust and reciprocity, social signaling, stabilizing cooperation, dispute resolution, institution formation, virtual economics, and authentication and several hours of brainstorming, we came up with some sort of loosely joined research agenda as well as two or three more specific project ideas. In my perception, the multi-layered discussions centered around three core questions or perspectives: (1) What have we learned and what can we learn from existing and evolving digital institutions? (2) How could we build or use digital institutions to address or solve specific problems? (3) How can we change the offline environment to support the formation of digital institutions? The two days have made clear that in each area we are only at the beginning of a long, but exciting and promising conversation.

Emergence of Digital Institutions


I had the great pleasure to participate in the International Society for New Institutional Economics’ 9th Annual Conference that took place in my favorite European city Barcelona. Professor Oliver Goodenough from Vermont Law School organized and chaired an interesting panel on the design and function of digital institutions. It turned out that New Institutional Economists, by and large, have not yet explored this topic in such a great detail as one would expect, and Oliver’s session, in fact, was the only one at the conference dealing with cyber-issues at all (which is a bit surprising given the breadth and depth of the conference — check the program.) Oliver did a terrific job in framing the key questions we were talking about – “we” also includes Berkman Fellow John Clippinger, who presented some striking theses about cyber-institutions born out of social networks and their interactions with institutions of the offline world. My own contribution is posted here. Thanks to Oliver, John Clippinger and, last but not least, John Palfrey for making the conversation possible.

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