Full text for verification
Dynamic Regulation via Governmental Contracts
Canonical record: https://ssrn.com/abstract=2517677
40 protected claims are extracted from this work, recorded under the identifier kaal-2014-dynamicregulationviagove.
Source extraction SHA-256: da2497c47641b9e455031a4e2685710636e64e9680cbb17681c74930797cfc7b
# Law & Economics Festschrift für Peter Nobel zum 70. Geburtstag Herausgegeben von: Robert Waldburger Peter Sester Christoph Peter Charlotte M. Baer Stämpfli Verlag # **Law & Economics Festschrift für Peter Nobel zum 70. Geburtstag** © Stämpfli Verlag AG Bern Friedrich Dürrenmatt Portrait Peter Nobel 1988, Gouache auf schwarzem Karton, 99,5 × 69,8 cm © Centre Dürrenmatt Neuchâtel, Schweizerische Eidgenossenschaft © Stämpfli Verlag AG Bern # **Law & Economics** ## **Festschrift für Peter Nobel zum 70. Geburtstag** Herausgegeben von: Robert Waldburger Peter Sester Christoph Peter Charlotte M. Baer y Stämpfli Verlag © Stämpfli Verlag AG Bern Bibliografische Information der Deutschen Nationalbibliothek Die Deutsche Nationalbibliothek verzeichnet diese Publikation in der Deutschen Nationalbibliografie; detaillierte bibliografische Daten sind im Internet über http://dnb.d-nb.de abrufbar. Alle Rechte vorbehalten, insbesondere das Recht der Vervielfältigung, der Verbreitung und der Übersetzung. Das Werk oder Teile davon dürfen ausser in den gesetzlich vorgesehenen Fällen ohne schriftliche Genehmigung des Verlags weder in irgendeiner Form reproduziert (z.B. fotokopiert) noch elektronisch gespeichert, verarbeitet, vervielfältigt oder verbreitet werden. © Stämpfli Verlag AG Bern · 2015 Dieses Werk ist in unserem Buchshop unter www.staempfliverlag.com erhältlich. ISBN Print 978-3-7272-2971-8 ISBN Judocu 978-3-0354-1239-0 © Stämpfli Verlag AG Bern # **Dynamic Regulation via Governmental Contracts** WULF A. KAAL ### **Content** |I.|Intr|oduction......................................................................................|65| |---|---|---|---| |II.|Dy|namic Regulation ........................................................................|67| ||1.|Learning Process to Improve Regulatory Information.............|67| ||2.|Feedback Effects ......................................................................|71| ||3.|Anticipatory Rulemaking .........................................................|73| ||4.|Supplementing the Regulatory Framework..............................|74| ||5.|Dynamic Corporate Governance..............................................|76| |III.|Go|vernmental Contracts ..................................................................|79| ||1.|Preemtive Remedial Measures .................................................|80| ||2.|Institution-Specific Governance Improvements.......................|81| |IV.|Dy|namic Regulation Via Governmental Contracts..........................|82| ||1.|Improving Incomplete Contracting ..........................................|82| ||2.|Multilevel Feedback Effects.....................................................|84| ||3.|Ex-Ante Experimentation.........................................................|87| ||4.|Facilitating Anticipatory Rulemaking ......................................|89| ||5.|Backward-Looking Ex-Ante Governance................................|90| |V.|Co|nclusion.......................................................................................|91| ## **I. Introduction** The concept of dynamic regulation in this article describes a supplemental regulatory tool that increases the availability of relevant, institution-specific, and decentralized information for rulemaking through feedback effects<sup>1</sup> . Prior literature discussed dynamic regulation predominantly in the context of telecommunication markets<sup>2</sup> , continuing regulatory relationships<sup>3</sup> , innovation and > 1 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828. > 2 BAUER, J. M., & BOHLIN, E. (2008). From static to dynamic regulation: Recent developments in US telecommunications policy. Intereconomics, 43, 38-50; DE BIJL, P. W. J., & PEITZ, M. (2004). Dynamic regulation and entry in telecommunications markets: A policy framework. Information Economics and Policy, 16, 411-437; and VAN DIJK, M., & MULDER, M. (2005). Regulation of telecommunication and deployment of broadband (CPB Memorandum No. 131). Retrieved from CPB Netherlands Bureau for Economic Policy Analysis website: http://www.cpb.nl/en/publication/regulation-telecommunication-anddeployment-broadband. > 3 LEWIS, T. R., & YILDIRIM, H. (2002). Learning by doing and dynamic regulation. RAND Journal of Economics, 33, 22-36. © Stämpfli Verlag AG Bern WULF A. KAAL learning by doing<sup>4</sup> , regulation of quality<sup>5</sup> , as well as principal-agent and adverse-selection problems<sup>6</sup> . LAFFONT AND TIROLE<sup>7</sup> analyzed incentive contracts in a dynamic framework and the ratchet effect in regulatory relationships of subsequent short-term contracts. The role of governmental contracts in facilitating dynamic elements in regulation has not been systematically analyzed. This article fills the gap in the literature. Rulemakers can integrate dynamic elements in regulation by utilizing feedback processes such as (i) intrajurisdictional exchanges and synergies between public rulemakers and regulators, (ii) intrajurisdictional feedback effects between private and public rulemakers, (iii) interjurisdictional feedback processes, (iv) informal rules, and (v) organizational culture<sup>8</sup> . The combination of these feedback processes can result in a sequence of mutuallyreinforcing, information-enhancing events that facilitate relevant, institutionspecific, and decentralized information for rulemaking in a dynamic framework. Enhanced institution-specific information for rulemaking allows for institution-specific ex-ante experimentation (before the enactment of rules)<sup>9</sup> . The combination of feedback processes, enhanced information for rulemaking, and institution-specific ex-ante experimentation facilitate anticipation of future contingencies for rulemaking. Adapting rules to identified future contingencies becomes the focal point for rulemaking in a dynamic framework<sup>10</sup> . Anticipatory dynamic elements in regulation can help minimize costly and suboptimal ex-post trial-and-error experimentation with stable and presumptively optimal rules _._ Governmental contracts can facilitate dynamic elements in regulation by enabling a combination of feedback processes that enhance the availability of relevant, institution-specific, and decentralized information for rulemaking. By evaluating regulatory necessities for specific institutions, governmental contracts can enable institution-specific ex-ante experimentation with regula- > 4 BARON, D. P., & BESANKO, D. (1984). Regulation and information in a continuing relationship. Information Economics and Policy, 1, 267-302. > 5 AURAY, S., MARIOTTI, T., & MOIZEAU, F. (2011). Dynamic regulation of quality. RAND Journal of Economics, 42, 246-265. > 6 LITWACK, J. M. (1992). Dynamic regulation, demand information and market prices. Stanford, CA: Stanford University. > 7 LAFFONT, J. J., & TIROLE, J. (1988). The dynamics of incentive contracts, Econometrica, 56, 1153-1175 and LAFFONT, J. J., & TIROLE, J. (1993). A theory of incentives in procurement and regulation. Cambridge, MA: MIT Press. > 8 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 9 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 10 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts tory solutions. The dynamic process of ex-ante experimentation with institution-specific regulatory solutions enables anticipation of future contingencies for rulemaking in specific industries. Anticipating and adapting rules to such identified future contingencies becomes possible. After a short introduction, in Part I the author discusses the core features of dynamic elements in regulation. Part II introduces the core features of governmental contracts and preemptive remedial measures that often precede governmental contracts. Part III shows how governmental contracts can facilitate dynamic elements in regulation. The author shows that governmental contracts and associated preemptive remedial measures provide feedback effects between the government regulators and the corporate wrongdoers that can increase relevant information for regulation. A short conclusion follows Part III. # **II. Dynamic Regulation** Supplementing the regulatory infrastructure with dynamic elements can help address suboptimal regulatory outcomes<sup>11</sup> . Dynamic elements in the regulatory infrastructure can be conceptualized as an economizing device that addresses the scarcity of regulatory resources and lowers the cost of rulemaking by curtailing the effects of a classic collective action problem in rulemaking, resulting regulatory cycles, and trial-and-error rulemaking. Rather than engaging in suboptimal trial-and-error rulemaking under conditions of incomplete information and bounded rationality, rulemaking in a dynamic framework postpones enacting rules until rulemakers have sufficient relevant and institution-specific information for rulemaking<sup>12</sup> . Ex-ante experimentation with institution-specific rules based on relevant information becomes the focal point of rulemaking in a dynamic framework. ## **1. Learning Process to Improve Regulatory Information** The theoretical framework of New Institutional Economics (NIE) can integrate dynamic elements that enable a learning process to improve information for rulemaking<sup>13</sup> . The emphasis in the theory of NIE on the function- > 11 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828 and KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 12 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828 and KAAL, W. A. (2014). > 13 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828 and KAAL, W. A. (2014). © Stämpfli Verlag AG Bern WULF A. KAAL ing and improvement of institutions<sup>14</sup> requires rule analysis within a given institutional context. NIE recognizes that transaction costs, imperfect information, and bounded rationality impact the rulemaking process, rendering even optimal solutions to regulatory problems unstable and suboptimal over time<sup>15</sup> . In NIE’s theoretical framework, experimentation with different rules and institutional frameworks can result in a learning process that can help overcome the shortcomings in the rulemaking process and help optimize institutional design<sup>16</sup> . Experimentation in the NIE framework is most appropriately illustrated by the core tenets of incomplete contract theory. According to incomplete contract theory, the rulemaking process is a learning process facilitated by incomplete contracts<sup>17</sup> . Incomplete contracts can overcome unintended side- - 14 - 14 RONALD COASE, The new institutional economics. The American Economic Review, 88(2), 72-74, 1998; FURUBOTN, E. G., & RICHTER, R. (2005). Institutions and economic theory: The contribution of the new institutional economics. Ann Arbor: University of Michigan Press; KIRCHNER, C. (2007). Public choice and new institutional economics: A comparative analysis in search of co-operation potentials. In P. Baake, & R. Borck (Eds.), Public economics and public choice: Contributions in honor of Charles B. Blankart (pp. 19-37). New York, NY; SPRINGER; NORTH, D. C. (1990). Institutions, institutional change and economic performance. New York, NY: Cambridge University Press; RICHTER, R., & FURUBOTN, E. G. (2005). Neue institutionenökonomik [New institutional cconomics]. Tübingen, Germany: Mohr Siebeck; WILLIAMSON, O. E. (1979). Transaction-cost economics: The governance of contractual relations. The Journal of Law and Economics, 22, 233-261; WILLIAMSON, O. E. (1985). The economic institutions of capitalism: Firms, markets, relational contracting. New York, NY: Free Press. - 15 HOMANN, K., & KIRCHNER, C. (1995). Ordnungsethik. In P. Herder-Dorneich, K.-E. Schenk, & D. Schmidtchen (Eds.), Jahrbuch für neue politische Ökonomie: Von der Theorie der Wirtschaftssysteme zur ökonomischen Systemtheorie (pp. 189-211). Tübingen: Mohr Siebeck; FURUBOTN, E. G., & RICHTER, R. (2005). Institutions and economic theory: The contribution of the new institutional economics. Ann Arbor: University of Michigan Press. - 16 HOMANN, K., & KIRCHNER, C. (1995). Ordnungsethik. In P. Herder-Dorneich, K.-E. Schenk, & D. Schmidtchen (Eds.), Jahrbuch für neue politische Ökonomie: Von der Theorie der Wirtschaftssysteme zur ökonomischen Systemtheorie (pp. 189-211). Tübingen: Mohr Siebeck; FURUBOTN, E. G., & RICHTER, R. (2005). Institutions and economic theory: The contribution of the new institutional economics. Ann Arbor: University of Michigan Press, KIRCHNER, C., PAINTER, R., & KAAL, W. A. (2005). Regulatory competition in EU corporate law after Inspire Art: Unbundling Delaware’s product for Europe. European Company and Financial Law Review, 2, 159-206; KIRCHNER, C., PAINTER, R., KAAL, W. A., & HÖPPNER, S. (2012). Europäischer vs. US-amerikanischer Wettbewerb der Gesellschaftsrechte - Abschied vom alten Delaware-Verbundprodukt. Die Aktiengesellschaft, 469-477. - 17 FURUBOTN, E. G., & RICHTER, R. (2005). Institutions and economic theory: The contribution of the new institutional economics. Ann Arbor: University of Michigan Press; HART, O., & MOORE, J. (1999). Foundations of incomplete contracts. The Review of Economic Studies, 66, 115-138; KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171; MACNEIL, I. R. (1974). The many futures of contracts. Southern California Law Review, 47, 691-816; SCHANZE, E. (1991). Symbiotic contracts: Exploring long-term agency structures between contract and corporation. In C. Joerges (Ed.), Franchising and the law: Theoretical and comparative approaches in Europe and the United States (pp. 67-104). Baden-Baden, Germany: Nomos; SCHANZE, E. (1993). Symbiotic arrangements. Journal of Institutional and Theoretical Economics, 149, 691-697; SCHANZE, E. (2005). International © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts effects and suboptimal rules resulting from bounded rationality and incomplete information<sup>18</sup> and optimize the rulemaking process<sup>19</sup> by leaving open provisions that require additional information<sup>20</sup> . Decisions are made when sufficient information becomes available, thus lowering incomplete information in the rulemaking process. Contracts are seen as a form of experimentation by way of observation for the learning process in the incomplete contract model<sup>21</sup> . The learning process in the incomplete contract model is faced with several challenges. First, a core tenet of incomplete contract theory – rulemakers should act when sufficient information becomes available – is often politically, economically, and practically undesirable or impossible. Because rulemaking is subject to regulatory cycles<sup>22</sup> and a classic collective action problem<sup>23</sup> , rules are generally not enacted when appropriate information for rulemaking becomes available. Rather, small and well-organized special interest groups dominate latent groups, such as dispersed investors, among others, in the competition to influence the rulemaking process<sup>24</sup> . Second, incomplete con- > standards: Functions and links to law. In P. Nobel (Ed.), International Standards and the Law (pp. 83-103). Berne, Switzerland: Staempfli. > 18 KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171; KOROBKIN, R. B., & ULEN, T. S. (2000). Law and behavioral science: Removing the rationality assumption from law and economics. California Law Review, 88, 1051-1144; MANTZAVINOS, C. (2001). Individuals, institutions, and markets. Cambridge, UK: Cambridge University Press. > 19 HOMANN, K., & KIRCHNER, C. (1995). Ordnungsethik. In P. Herder-Dorneich, K.-E. Schenk, & D. Schmidtchen (Eds.), Jahrbuch für neue politische Ökonomie: Von der Theorie der Wirtschaftssysteme zur ökonomischen Systemtheorie (pp. 189-211). Tübingen: Mohr Siebeck; FURUBOTN, E. G., & RICHTER, R. (2005). Institutions and economic theory: The contribution of the new institutional economics. Ann Arbor: University of Michigan Press; KIRCHNER, C., PAINTER, R., & KAAL, W. A. (2005). Regulatory competition in EU corporate law after Inspire Art: Unbundling Delaware’s product for Europe. European Company and Financial Law Review, 2, 159-206; KIRCHNER, C., PAINTER, R., KAAL, W. A., & HÖPPNER, S. (2012). Europäischer vs. US-amerikanischer Wettbewerb der Gesellschaftsrechte - Abschied vom alten Delaware-Verbundprodukt. Die Aktiengesellschaft, 469-477. - 20 KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171. - 21 KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171. - 22 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; COFFEE, J. C., JR. (2012). The political economy of Dodd-Frank: Why financial reform tends to be frustrated and systemic risk perpetuated. Cornell Law Review, 97, 1019-1082; OSTROM, E. (1990). Governing the commons: The evolution of institutions for collective action. Cambridge, UK: Cambridge University Press. - 23 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; OLSON, M. (1965). The logic of collective action. Cambridge, MA: Harvard University Press. - 24 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; COFFEE, J. C., JR. (2012). The political economy of Dodd-Frank: Why financial reform tends to be frustrated and systemic risk perpetuated. Cornell Law Review, 97, 1019-1082; OSTROM, E. (1990). Governing the commons: The evolution of institutions for collective action. Cambridge, UK: Cambridge University Press. © Stämpfli Verlag AG Bern WULF A. KAAL tract theory’s emphasis on experimentation with different rules creates significant transaction costs. The costs of rule revision, rule enactment, and experimentation in the current framework of stable rulemaking are substantial, especially because there is some evidence<sup>25</sup> that the existing rulemaking framework does not protect against systemic shocks and financial crises. Dynamic elements in regulation can improve the learning process in the incomplete contract model<sup>26</sup> . A search process facilitates the learning process in the incomplete contract model<sup>27</sup> . Dynamic elements in regulation via feedback effects can be seen as part of that search process. More specifically, dynamic regulation in the incomplete contract framework helps make relevant, timely, decentralized, and institution-specific information available for rulemaking through feedback processes<sup>28</sup> . In the current model of stable rulemaking, path dependencies may lead rulemakers to act based on a boundedly rational assumption of control over sufficient information for rulemaking. Feedback processes in the framework of dynamic regulation, however, allow rulemakers to defer action until sufficient information has been made available for rulemaking. The improvement of the learning process via feedback effects can culminate in the anticipation of future contingencies for rulemaking<sup>29</sup> . Rulemakers’ adaptation to such future contingencies becomes part of the rulemaking process<sup>30</sup> . Dynamic and adaptable rulemaking is possible if dynamic rulemaking processes facilitate timely, relevant, and decentralized information for rulemaking via feedback effects. Governmental contracts create feedback effects that can facilitate the anticipation of future contingencies and enable dynamic and adaptable rulemaking. > 25 REINHART, C. M. & ROGOFF, K. (2009). This time is different: eight centuries of financial folly. Princeton, NJ: Princeton University Press. > 26 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 27 KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171. > 28 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 29 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 30 KAAL, W.A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts # **2. Feedback Effects** The theory of lawmaking describes feedback effects as rulemakers’ reactions to institutional change<sup>31</sup> or private actors’ reactions and counteractivities to institutional constraints<sup>32</sup> . By contrast, feedback effects in a dynamic regulatory framework can enhance the availability of institution-specific and decentralized information to support the rulemaking process<sup>33</sup> . Rules and rulemaking processes interact and evolve over time, and feedback effects between institutions and outcomes and between private and public rulemakers facilitate and enhance the evolution of the rulemaking process<sup>34</sup> . Interjurisdictional feedback processes can be distinguished from intrajurisdictional feedback processes<sup>35</sup> . Interjurisdictional feedback processes can originate from competition between legislators and regulators<sup>36</sup> . Intrajurisdictional feedback processes include synergies and exchanges between public rulemakers and public regulators as well as intrajurisdictional feedback processes between private and public rulemakers in a given jurisdiction<sup>37</sup> . Informal rules and organizational culture can also create feedback effects for rulemaking<sup>38</sup> . The combination of feedback processes can result in mutuallyreinforcing information-enhancing events to minimize ex-post trial-and-error experimentation with stable and presumptively optimal rules<sup>39</sup> . > 31 DETHIER, J. (1999). Governance and economic performance: A survey (Discussion Paper No. 5, Zentrum für Entwicklungsforschung [Center for Development Research]). Retrieved from > http://citeseerx.ist.psu.edu/viewdoc/download;jsessionid=D05CA614163CF315CE3C47685 86EDF56?doi=10.1.1.200.310&rep=rep1&type=pdf. > 32 KIRCHNER, C. (1995). Market organization: A new-institutional perspective. Journal of Institutional and Theoretical Economics, 151, 260-267. > 33 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. - 34 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. - 35 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. - 36 KIRCHNER, C., PAINTER, R., & KAAL, W. A. (2005). Regulatory competition in EU corporate law after Inspire Art: Unbundling Delaware’s product for Europe. European Company and Financial Law Review, 2, 159-206; KIRCHNER, C., PAINTER, R., KAAL, W. A., & HÖPPNER, S. (2012). Europäischer vs. US-amerikanischer Wettbewerb der Gesellschaftsrechte - Abschied vom alten Delaware-Verbundprodukt. Die Aktiengesellschaft, 469-477. - 37 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. - 38 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. - 39 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern WULF A. KAAL Intrajurisdictional feedback processes between private and public rulemakers in a given jurisdiction can significantly increase the availability of relevant, decentralized, and timely information for rulemaking. Private rulemakers often have a comparative advantage over public rulemakers because, unlike their public counterparts, they often can produce necessary, comparable, decentralized, and institution-specific information for rulemaking. Unlike public rulemakers, private rulemakers often have access to decentralized information and can more readily react to emerging, decentralized, and institution-specific information. Interaction between public rulemakers and private rulemakers, including the exchange of emerging information, creates a feedback process between them that increases the availability, timeliness, and quality of information available to the public rulemaker. Based on the optimized information for rulemaking, the public rulemaker can take regulatory action when the relevant information for rulemaking becomes available. The interplay between public and private rulemakers and the associated feedback process enables a learning process and optimization process for the public rulemaker _._ Cooperation and the unrestricted exchange of information for rulemaking between different public rulemakers can create synergies and, thus, facilitate feedback effects that improve public rulemaking<sup>40</sup> . The rulemaking process is enhanced through the competition between different public rulemakers because it adds a market-driven element to the rulemaking process. More specifically, intrajurisdictional competition between different public rulemakers can require public rulemakers to meet consumers’ and legal addressees’ quality expectations and preferences. Intrajurisdictional consumer choice can add a dynamic element to the rulemaking process because public rulemakers in a given jurisdiction can adjust rulemaking to consumer choice once consumers have opted out of a suboptimal regulatory regime in that jurisdiction. In effect, consumer choice creates a feedback effect for the public rulemaker. Consumer choice can thus facilitate appropriate information for rulemaking and enable anticipation and modification of the public rulemaker’s next action in the rulemaking process. Informal rules, such as social norms and customs that are formalized and enforced<sup>41</sup> , can create feedback processes and provide relevant information for rulemaking. Informal rules and practices can provide relevant information for the public rulemaking process and can help improve public rulemaking. Feedback effects may exist between public rulemakers and parties who are subject to informal rules if public rulemakers observe the preferences and > 40 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W.A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 41 KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts efficient solutions of parties who are subject to informal rules. In effect, parties who are subject to informal rules are signaling their preferences and efficient solutions to the public rulemaker. Public rulemakers can benefit from the additional insights such signaling may produce for the public rulemaking process. Finally, the characteristics of existing rules create a feedback effect for the rulemaking process itself. Suboptimal rules and rulemaking processes that are not adaptable to future requirements reinforce rulemaking processes and institutions that produce suboptimal outcomes. The existing framework for stable and presumptively optimal rules reinforces rulemaking processes that perpetuate stable and presumptively optimal rules, necessitating costly rule revision, updating, and revocation. # **3. Anticipatory Rulemaking** Anticipatory dynamic regulation can help minimize costly and suboptimal expost trial-and-error experimentation with stable and presumptively optimal rules _._ Rather than acquiring the necessary information ex-post after rules have emerged as suboptimal, feedback effects help increase the availability of relevant information for rulemaking ex-ante and anticipate necessary revisions before rules emerge as suboptimal<sup>42</sup> . The combination of feedback processes, enhanced information for rulemaking, and institution-specific ex-ante experimentation facilitate the anticipation of future contingencies for rulemaking. Adapting rules to such identified future contingencies becomes the focal point for rulemaking in a dynamic framework<sup>43</sup> . Increased information for rulemaking facilitates anticipation of future contingencies in the rulemaking process and enables the rulemaker to modify the next action in the rulemaking process. The timeliness and quality of information becomes the focus of rulemaking in a dynamic framework<sup>44</sup> . The increased availability of relevant, decentralized, and timely information for rulemaking in a dynamic framework can help facilitate rulemakers’ predictions and anticipation of otherwise unforeseeable contingencies, making anticipatory action by rulemakers possible. > 42 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. 43 > 43 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 44 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern WULF A. KAAL # **4. Supplementing the Regulatory Framework** Dynamic elements in regulation as a regulatory supplement can help address the shortcomings of the existing rulemaking framework and curtail increased demands on the institutional infrastructure. The institutional infrastructure for rulemaking was traditionally geared towards the creation of stable rules for governing a comparatively small, stable, and disconnected society with limited upward mobility and relatively stable economic and market environments. The rapidly growing number of rule enactments, revisions, and revocations<sup>45</sup> seems to suggest that the existing regulatory infrastructure is incapable of adequately and sustainably addressing the rapid pace of changes in demands on regulators. Financial innovation, increasing speed of order execution and algorithmic trading, and the increasing complexities of financial markets and their interconnectedness, among other factors, require a rulemaking infrastructure that is capable of continuous adjustments to these challenges. Several systemic constraints in the existing rulemaking framework and regulatory infrastructure contribute to its adjustment challenges. The existing regulatory infrastructure is subject to a classic collective action problem<sup>46</sup> , regulatory cycles<sup>47</sup> , and trial-and-error rulemaking<sup>48</sup> , among other challenges. Smaller and better-organized special interest groups typically control dispersed investors and other dominant latent groups in the competition to influ- > 45 MCDONNELL, B. (2013). Dampening financial regulatory cycles. Florida Law Review, 65, 1597-1651. 46 > COFFEE, J. C., JR. (2012). The political economy of Dodd-Frank: Why financial reform tends to be frustrated and systemic risk perpetuated. Cornell Law Review, 97, 1019-1082; KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck; OLSON, M. (1965). The logic of collective action. Cambridge, MA: Harvard University Press. > 47 COFFEE, J. C., JR. (2012). The political economy of Dodd-Frank: Why financial reform tends to be frustrated and systemic risk perpetuated. Cornell Law Review, 97, 1019-1082; KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck; OLSON, M. (1965). The logic of collective action. Cambridge, MA: Harvard University Press. > 48 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck; KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171; POPPER, K. R. (1957). The poverty of historicism. London, U.K.: Routledge. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts ence the rulemaking process<sup>49</sup> . The predominance of special interest groups in the rulemaking process can be temporarily overcome during and after crises when political entrepreneurs assume the transaction costs of organizing the otherwise disinterested latent groups<sup>50</sup> . The existing rulemaking infrastructure is also subject to costly regulatory cycles<sup>51</sup> . To the extent that rulemakers appreciate the existence of unknown future contingencies, they often willingly accept or discount such future contingencies which can affect the quality of rules, their scope, and continuing relevance. The political, economic, and transactional circumstances at the time of rule enactment and the corresponding rule requirements inevitably change. If and when identified future contingencies are realized and the existing sets of rules prove to be suboptimal, rule revisions become necessary<sup>52</sup> _._ Traditional trial-and-error-rulemaking exacerbates the systemic shortcomings of the existing rulemaking framework. The trial-and-error approach<sup>53</sup> to rulemaking does not allow rulemakers to attain relevant information for rulemaking ex-ante, before rules are enacted. Rather, in the existing trial-anderror approach to rulemaking, rulemakers acquire the relevant information for rulemaking ex-post, typically after it becomes apparent that the existing set of rules is suboptimal. This form of experimentation via ex-post rule revision is deemed necessary in the existing regulatory framework because the actual requirements for rules become clear when stable and presumptively optimal rules emerge as suboptimal. Because of trial-and-error rulemaking with presumptively optimal and stable rules in the existing regulatory framework, exante experimentation with rules and anticipation of future contingencies does not play a (sufficient) role. The existing shortcomings are systemic and an integral part of the existing stable and presumptively optimal rulemaking framework. They are unlikely to be adequately addressed within the existing institutional infrastructure because the structure of the existing regulatory framework is based on the assumption that rules ought to be stable and presumptively optimal to address a given regulatory problem. Collective action problems, regulatory cycles, and trial-and-error rulemaking, among other shortcomings, are less likely to exist > 49 OLSON, M. (1965). The logic of collective action. Cambridge, MA: Harvard University Press. > 50 > 50 OSTROM, E. (1990). Governing the commons: The evolution of institutions for collective action. Cambridge, UK: Cambridge University Press. 51 > 51 COFFEE, J. C., JR. (2012). The political economy of Dodd-Frank: Why financial reform tends to be frustrated and systemic risk perpetuated. Cornell Law Review, 97, 1019-1082. > 52 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828. > 53 KIRCHNER, C. (2011). Evolution of law: Interplay between private and public rule-making: A new institutional economics analysis. Erasmus Law Review, 4, 161-171; POPPER, K. R. (1957). The poverty of historicism. London, U.K.: Routledge. © Stämpfli Verlag AG Bern WULF A. KAAL (at least to the extent presented) if the existing stable and presumptively optimal rulemaking framework could be supplemented with dynamic elements. Dynamic and anticipatory elements in the existing stable and presumptively optimal regulatory infrastructure can function as a regulatory supplement to counteract existing shortcomings in the rulemaking process<sup>54</sup> . The collective action problem partially exists in the current rulemaking process because smaller and better-organized interest groups and dominant latent groups which are competing to influence the rulemaking process assume that regulatory outcomes are stable and not (easily) adaptable to future contingencies. The inadaptability of rules and the stable and presumptively optimal rulemaking in the current regulatory framework may intensify the competition between the two groups because it increases the stakes for both interest groups. Similarly, rule adoption, revisions, and revocations create regulatory cycles because stable and presumptively optimal rules do not adapt to future contingencies and corresponding regulatory needs. Costly regulatory cycles are less likely to exist if the existing regulatory framework integrates dynamically adapting elements in the rulemaking process because rule revisions, revocations, and reenactments become less likely. Finally, traditional trial-and-errorrulemaking exists because regulatory solutions are presumptively optimal and stable. Trial-and-error-rulemaking could become obsolete if dynamic elements in rulemaking processes systematically anticipated future contingencies and corresponding regulatory needs. # **5. Dynamic Corporate Governance** The core tenets of dynamic and anticipatory rulemaking distinguish the corresponding dynamic governance structure from other theoretical governance constructs. Corporate governance is generally portrayed in the literature as a forward-looking ex-ante endeavor. NIE equally views corporate governance as a forward-looking system to remedy the incompleteness of contracting. By contrast, in the theoretical framework of dynamic regulation, dynamic governance structures can be categorized as backward-looking ex-ante forms of corporate governance. The majority of scholars define corporate governance as a forwardlooking ex-ante endeavor with various permutations and emphases in the definitions. Corporate governance structures are generally designed to set up a system of checks and balances between investors, management, and the board for purposes of managing and safeguarding efficiently functioning cor- > 54 KAAL, W. A. (2013). Dynamic regulation of the financial services industry. Wake Forest Law Review, 48, 791-828; KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts porations to create value. In a world of agency problems and incomplete contracts, corporate governance is a mechanism for decision making in the incomplete contract environment that helps allocate residual rights over assets<sup>55</sup> . Corporate governance also addresses the ways in which corporations’ creditors and suppliers of finance ensure a return on their investment<sup>56</sup> . The combination of institutions and mechanisms, including contracts, laws, and norms, in corporate governance enables investors to control corporate management’s deviance from their promises<sup>57</sup> . Other scholars, however, focus on the after-the-fact nature of correctives and see corporate governance as a (forward-looking) ex-post system<sup>58</sup> . Corporate governance is seen as continually moving in the ex-post direction because of a heavy reliance on market correctives such as manager-driven insolvency and takeovers<sup>59</sup> . Corporate governance in this model is integrally related to the nature of the corresponding bankruptcy regime<sup>60</sup> . In the theoretical framework of NIE, corporate governance is also forward-looking. In NIE, corporations are seen as legal institutions consisting of interconnecting contracts among the suppliers of factors of production for lowering the transaction costs of organizing production within the firm<sup>61</sup> . Corporate governance in turn is seen as the institutional structure set up by parties to address the inevitable incompleteness of contracting<sup>62</sup> . Corporate governance systems enable the firm to internalize transactions characterized by uncertainty and high asset specificity<sup>63</sup> . Because contractual protections are insufficient to ensure safeguarding shareholders’ investments, board monitoring and management of the firm facilitates the protection of firm-specific investments<sup>64</sup> . Opportunism and bounded rationality prevent boards and management from fully protecting shareholders’ interests. Dynamic governance structures can be categorized as backward-looking ex-ante forms of corporate governance. Dynamic governance structures are > 55 HART, O. (1995a). Corporate governance: Some theory and implications. The Economic Journal, 105, 678-689. > 56 SHLEIFER, A., & VISHNY, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52, 737-783. > 57 MACEY, J. R. (2008). Corporate governance: Promises kept, promises broken. Princeton, NJ: Princeton University Press. > 58 SKEEL, D. A., JR. (1998). An evolutionary theory of corporate law and corporate bankruptcy. Vanderbilt Law Review, 51, 1325-1398. > 59 SKEEL, D. A., JR. (1999). The market revolution in bank and insurance firm governance: Its logic and limits. Washington University Law Quarterly, 77, 433-459. > 60 SKEEL, D. A., JR. (1998). An evolutionary theory of corporate law and corporate bankruptcy. Vanderbilt Law Review, 51, 1325-1398. > 61 SCOTT, K. E. (1984). Corporate governance and the new institutional economics. Journal of Institutional and Theoretical Economics, 140, 136-152. > 62 WILLIAMSON, O. E. (1985). The economic institutions of capitalism: Firms, markets, relational contracting. New York, NY: Free Press. > 63 WILLIAMSON, O. E. (1984). Corporate governance. The Yale Law Journal, 93, 1197-1230. > 64 WILLIAMSON, O. E. (1984). Corporate governance. The Yale Law Journal, 93, 1197-1230. © Stämpfli Verlag AG Bern WULF A. KAAL backward-looking because feedback effects in dynamic regulation necessitate an exchange of information pertaining to past events to anticipate future contingencies. Feedback effects invariably include the analysis of past events. Intrajurisdictional feedback processes<sup>65</sup> , including synergies and exchanges between public rulemakers and between private rulemakers, require an investigation of past events. Interjurisdictional feedback processes<sup>66</sup> , including competition between legislators<sup>67</sup> among others, equally demand analyses of past regulatory demands, corresponding suboptimal regulatory solutions, and associated regulatory optimization requirements. Corporate governance in dynamic regulation also embodies an ex-ante endeavor because the feedback effects in dynamic regulation increase the availability of relevant institutionspecific information for rulemaking before rulemakers act and thus minimize ex-post trial-and-error experimentation with stable and presumptively optimal rules. Dynamic backward-looking ex-ante corporate governance structures can be contrasted with traditional forward-looking corporate governance perspectives. The institutional infrastructure and the systemic assumption in existing rulemaking structures that rules ought to be stable and presumptively optimal rarely require traditional forward-looking corporate governance systems to take backward-looking perspectives. Traditional forward-looking corporate governance systems may take backward-looking perspectives if and when stable and optimal rules emerge as suboptimal, requiring replacement and/or amendment of existing regulatory solutions. By contrast, dynamic governance structures constantly evaluate past, present, and future solutions for regulatory issues and demands through feedback effects. Future regulatory solutions are based on the analysis of feedback effects that center around the exchange between past and present solutions. > 65 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 66 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 67 KIRCHNER, C., PAINTER, R., & KAAL, W. A. (2005). Regulatory competition in EU corporate law after Inspire Art: Unbundling Delaware’s product for Europe. European Company and Financial Law Review, 2, 159-206; KIRCHNER, C., PAINTER, R., KAAL, W. A., & HÖPPNER, S. (2012). Europäischer vs. US-amerikanischer Wettbewerb der Gesellschaftsrechte - Abschied vom alten Delaware-Verbundprodukt. Die Aktiengesellschaft, 469-477. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts # **III. Governmental Contracts** Governmental contracts are contractual arrangements executed between the government and a corporate entity that allow the government to impose sanctions against the respective entity and set up institutional changes in exchange for the government’s agreement to forego further investigation and corporate criminal indictment<sup>68</sup> . The characteristics of governmental contracts, as described in this article, are most commonly identifiable in non- and deferred prosecution agreements (N/DPAs)<sup>69</sup> . Governmental contracts enable corporations to resolve allegations of corporate criminal conduct, strengthen corporate compliance mechanisms to prevent corporate wrongdoing in the future, and mitigate the risks that the collateral consequences of a conviction can bring for companies, their shareholders, employees, and the economy. Empirical evidence suggests that the targeted use of governmental contracts allows the government to successfully reform corporate governance in public corporations and entire industries<sup>70</sup> . Over 97% of the N/DPAs executed in the United States between 1993 and 2013 contained governance changes, including required business changes (30%), board and senior management changes (38%), additional oversight by senior management, updated compliance programs, and enhanced self-reporting obligations, among others<sup>71</sup> . Since 2002, the government has significantly increased the use of N/DPAs, and this trend is continuing<sup>72</sup> , especially in the healthcare and financial industries<sup>73</sup> . Governmental contracts have consistently increased the use of monitors and expanded the monitors’ powers<sup>74</sup> , and they have heightened corporations’ compliance features<sup>75</sup> . The significant governance improvements attainable through the use of governmental contracts, as exemplified by N/DPAs<sup>76</sup> seem to counteract or at least discount concerns voiced over short- > 68 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 69 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 70 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 71 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 72 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 73 O’REILLY, J. T., HANLON J. P., HALL, R. F., JACKSON, S. L., & LEWIS, E. R. (2009). Punishing corporate crime: Legal penalties for criminal and regulatory violations. New York, NY: Oxford University Press. > 74 BOOZANG, K., M., & HANDLER-HUTCHINSON, S. (2009). "Monitoring" corporate corruption: DOJ's use of deferred prosecution agreements in health care. American Journal of Law and Medicine, 35, 89-124. > 75 > 75 GARRETT, B. L. (2007). Structural reform prosecution. Virginia Law Review, 93, 853-957. > 76 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern WULF A. KAAL comings in the use of governmental contracts<sup>77</sup> . Concerns that may be discounted include the unequal bargaining power between the contracting parties<sup>78</sup> , the government’s lack of governance expertise and training<sup>79</sup> , the potential for prosecutorial abuse<sup>80</sup> , the lack of a proper mandate for the government, the resulting inadequacy of compliance programs, and other inefficiencies<sup>81</sup> . # **1. Preemtive Remedial Measures** The execution of governmental contracts often follows attempts by the corporate wrongdoer to avoid corporate criminal indictment and/or the execution of a governmental contract. Over 60% of N/DPAs executed between 1993 and 2013 instituted preemptive remedial measures prior to the execution of the N/DPA<sup>82</sup> . Preemptive remedial measures can entail a variety of measures including appointment of a new board, appointment of new management, improved compliance measures, cooperation with the DOJ, increased disclosures, dismissing staff, internal review and investigations, increased monitoring, and increased training<sup>83</sup> . Preemptive remedial measures associated with governmental contracts and the associated governance improvements play an increasing role for boards, management, and their legal advisers<sup>84</sup> . Effective preemptive remedial > 77 PAULSEN, E. (2007). Imposing limits on prosecutorial discretion in corporate prosecution agreements. New York University Law Review, 82, 1434-1469; UHLMANN, D. M. (2013). Deferred prosecution and non-prosecution agreements and the erosion of corporate criminal liability. Maryland Law Review, 72, 1295-1344; WARIN, F. J., & SCHWARTZ, J. C. (1997). Deferred prosecution: The need for specialized guidelines for corporate defendants. Journal of Corporation Law, 23, 121-134, > 78 GARRETT, B. L. (2007). Structural reform prosecution. Virginia Law Review, 93, 853-957; COPLAND, J. R. (2012). The shadow regulatory state: The rise of deferred prosecution agreements. (Civil Justice Report No. 14). Retrieved from the Manhattan Institute for Policy Research, http://www.manhattan-institute.org/html/cjr_14; PAULSEN, E. (2007). Imposing limits on prosecutorial discretion in corporate prosecution agreements. New York University Law Review, 82, 1434-1469. - 79 BHARARA, P. (2007). Corporations cry uncle and their employees cry foul: Rethinking prosecutorial pressure on corporate defendants. American Criminal Law Review, 44, 53113; WRAY, C. A., & HUR, R. K. (2006). Corporate criminal prosecution in a post-Enron world: The Thompson memo in theory and practice. American Criminal Law Review, 43, 1095-1188. - 80 GARRETT, B. L. (2007). Structural reform prosecution. Virginia Law Review, 93, 853-957. 81 BAER, M. H. (2008). Insuring corporate crime. Indiana Law Journal, 83, 1035-1096; KRAWIEC, K. D. (2003). Cosmetic compliance and the failure of negotiated governance. Washington University Law Quarterly, 81, 487-544. - 82 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. - 83 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. - 84 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts measures can address the corporate wrongdoing before it causes a government investigation and thus enable the corporation to avoid the execution of governmental contracts. However, the majority of governmental contracts are executed after preemptive remedial measures have proved unsuccessful<sup>85</sup> , calling into question the effectiveness of existing preemptive remedial measures. Should future governmental contracts increasingly mandate replacement of boards and senior management (38% of governmental contracts from 1993 to 2013 replaced boards and management)<sup>86</sup> , boards may be further incentivized to optimize the effectiveness of preemptive remedial measures. # **2. Institution-Specific Governance Improvements** Governmental contracts can significantly improve the institution-specific governance of corporate wrongdoers<sup>87</sup> . KAAL and LACINE (in press)<sup>88</sup> have shown that since 2002, the execution of governmental contracts, as exemplified by N/DPAs, has increased substantially in the United States and has resulted in substantive governance improvements for corporate wrongdoers. They have shown that one third of the governmental contracts in their sample of publicly available governmental contracts executed between 1993 and 2013 contained provisions that substantively changed the corporate wrongdoers’ businesses. Similarly, more than one third of all publicly available governmental contracts in the sample contained provisions requiring board changes, such as inclusion of independent directors, restructuring of board committees, and additional board reporting obligations. In addition, nearly one third of contracts in the sample contained provisions that added oversight responsibilities for senior management and monitoring requirements<sup>89</sup> . Internal compliance and cooperation with the government play a significant and consistently increasing role in governmental contracts<sup>90</sup> . KAAL AND LACINE (in press)<sup>91</sup> have shown that almost three fourth of the governmental contracts executed between 1993 and 2013 contained provisions requiring > 85 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 86 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 87 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 88 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 89 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 90 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 91 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern WULF A. KAAL improved or expanded compliance programs. Such provisions included requiring improvements pertaining to books and records, the updating of compliance policies, improved communications, training requirements, requiring a compliance code, and requiring creation of the position of chief compliance officer<sup>92</sup> . Important categories of cooperation with the government in governmental contracts include the assembling and organizing of relevant documents, testimony by important agents of the corporate wrongdoer, and increased disclosures<sup>93</sup> . # **IV. Dynamic Regulation Via Governmental Contracts** Governmental contracts can facilitate dynamic elements in regulation. The power dynamics pertaining to the negotiation of governmental contracts and the terms of governmental contracts contain important features that enable dynamic regulation. Governmental contracts can enable dynamic regulation by facilitating a combination of multilevel feedback processes that enhance the availability of relevant, institution-specific, and decentralized information for rulemaking. Through the combination of multilevel feedback processes and improved institution-specific information, governmental contracts facilitate ex-ante experimentation with regulatory solutions for particular industries. The dynamic process of ex-ante experimentation with institutionspecific regulatory solutions enables anticipation of future contingencies for rulemaking in specific industries. Rules can be adapted to future contingencies in a dynamic process. ## **1. Improving Incomplete Contracting** NIE’s incomplete contract model recognizes that opportunistic behavior, transaction costs, and bounded rationality undermine comprehensive contracting. Because it is too costly for contracting parties to anticipate all contingencies and to agree to necessary contract adaptations in advance<sup>94</sup> , the contracting parties in the incomplete contract model do not specify all of their respective obligations under the contract ex-ante. Parties rely on control rights to minimize opportunistic behavior and postpone the specification of the exact > 92 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 93 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 94 WILLIAMSON, O. E. (1985). The economic institutions of capitalism: Firms, markets, relational contracting. New York, NY: Free Press. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts parameters of their respective duties until they have accumulated sufficient relevant information to make a decision<sup>95</sup> . Governmental contracts can help remedy the shortcomings of rulemaking in the incomplete contract model. Incomplete contract theory suggests experimentation with different rules and rulemaking when sufficient information is available. Rulemaking when sufficient information is available is often practically, economically, and politically impossible<sup>96</sup> . Experimentation with different rules in incomplete contract theory can create significant transaction costs<sup>97</sup> . Governmental contracts can lower the transaction costs of rulemaking, address the sufficiency of information for contracting, and help lower the degree of contractual incompleteness. Governmental contracts can help lower the transaction costs of experimentation with different rules in the incomplete contract model. Unlike contracting in traditional contracts, governmental contracts are only executed after the DOJ has identified and assessed corporate wrongdoing. The assessment of corporate wrongdoing enables the parties to contract for governance improvements with relative precision, allowing for less overall institutionspecific experimentation and lower associated transaction costs. For a majority of governmental contracts, preemptive remedial measures allow the corporate wrongdoer to remedy and/or avoid possible corporate criminal indictment before the execution of a governmental contract<sup>98</sup> . Rulemaking via governmental contracts is based on the findings of an investigation of wrongdoing and preemptive remedial measures which can lower the transaction costs otherwise associated with traditional rulemaking and experimentation with different rules in the incomplete contract rulemaking framework. Governmental contracts can address the practical impossibility of waiting with rulemaking in the incomplete contract model until sufficient information becomes available. Because regulatory action associated with governmental contracts is based on an entity-specific investigation of wrongdoing, entityspecific rulemaking via governmental contracts is usually based on a higher overall level of relevant and decentralized information for rulemaking. Accordingly, the delay in rulemaking until sufficient information is available can be minimized. Preemptive remedial measures preceding most governmental > 95 RICHTER, R. (1989). Banking regulation as seen by the new institutional economics. In E. G. Furubotn & R. Richter (Eds.), The economics and law of banking regulation, Center for the Study of New Institutional Economics (pp. 135–160). Occasional Papers, Vol. 2, Universität des Saarlandes, Saarbrücken. 96 > 96 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W.A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 97 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W.A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 98 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern WULF A. KAAL contracts allow a (relatively) accurate assessment of the sufficiency of information for regulatory action. The feedback processes associated with governmental contracts increase the overall level of relevant information for rulemaking by regulators. The combination of governmental investigation of wrongdoing, preemptive remedial measures, and associated multilevel feedback effects increases the availability of relevant information for rulemaking and allows for a shorter delay of rulemaking in the incomplete contract model. Governmental contracts can help clarify when information for rulemaking reaches sufficiency levels and lower the degree of contractual incompleteness. In incomplete contract theory, the degree of contractual incompleteness is determined by the contracting parties’ ability to anticipate opportunistic behavior, the cost of contracting<sup>99</sup> , and the degree of availability, timeliness, and quality of information. Multilevel feedback processes associated with governmental contracts allow the parties to produce, assess, and improve institution-specific, timely, and decentralized information. By utilizing the feedback effects associated with governmental contracts, rulemakers can more accurately assess the sufficiency of information for rulemaking. Deducing from improved institution-specific information, rulemakers can more readily assess whether other institutions or entire industries require similar rulemaking. Feedback processes associated with governmental contracts can lower contractual incompleteness because the feedback processes increase the degree of availability, timeliness, and quality of information and lower the cost of contracting. Feedback processes associated with governmental contracts also facilitate the anticipation of future contingencies for rulemaking. # **2. Multilevel Feedback Effects** Feedback effects play a significant role in the theory of dynamic regulation<sup>100</sup> . Feedback effects in the theory of dynamic regulation can take several different forms and permutations, including intrajurisdictional feedback effects in the form of exchanges and synergies between public rulemakers and regulators, intrajurisdictional feedback effects between private and public rulemakers, interjurisdictional feedback processes, informal rules, and organizational culture<sup>101</sup> . > 99 HART, O. (1995b). Firms, contracts, and financial structure. New York, NY: Oxford University Press. > 100 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W.A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. > 101 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts Governmental contracts exemplify the feedback processes conceptualized in the theory of dynamic regulation. Governmental contracts facilitate multilevel feedback processes by way of corporate self-investigation, selfreporting, preemptive remedial measures, negotiation of governmental contracts, continuing wrongdoing, and execution of governmental contracts between the corporate wrongdoer and the government. Feedback processes built into the terms of governmental contracts themselves, such as cooperation, monitoring obligations, and reporting obligations, further enhance the multilevel feedback processes between the corporate wrongdoer and regulators. Multilevel feedback effects improve the availability and quality of information for rulemaking ex-ante, helping to preempt suboptimal rules and minimizing ex-post trial-and-error rulemaking. Corporate wrongdoers’ self-investigation and self-reporting of corporate criminal conduct to the government can create feedback effects for rulemaking. The overwhelming majority of corporate wrongdoing never results in the execution of a governmental contract<sup>102</sup> . Rather, the majority of corporate criminal conduct is addressed via self-investigation and self-reporting. Selfinvestigation and reporting require corporate wrongdoers to identify the institutional wrongdoing and the associated shortcomings of internal corporate governance by way of internal fact-finding and investigation. Based on the additional institution-specific information made available through selfreporting, the government can identify institution-specific governance shortcomings and draw conclusions about regulatory needs in the respective industries. The feedback process associated with self-reporting of wrongful corporate conduct allows governmental regulators to go through a learning process that increases effective rulemaking. The low success rate of preemptive remedial measures, evidenced by the fact that over 60% of D/NPA executed between 1993 and 2013 refer to preemptive remedial measures<sup>103</sup> , suggests that a high proportion of internal investigations and preemptive remedial measures that precede the execution of governmental contracts can create feedback effects because the government can use corporate wrongdoers’ internal investigations for its own fact-finding / investigation of wrongful corporate conduct. Preemptive remedial measures associated with governmental contracts can facilitate feedback effects for rulemaking. Preemptive remedial measures are attempts by corporate wrongdoers to self-remedy corporate wrongdoing to avoid corporate criminal indictment. Governmental contracts are often executed after preemptive remedial measures intended to remedy the (often selfreported) corporate wrongdoing have proved unsuccessful and/or insufficient, > 102 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 103 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern WULF A. KAAL and the government has formally investigated the wrongdoing of the respective entity and its agents<sup>104</sup> . Preemptive remedial measures can create feedback effects for rulemaking because the attempts to institute measures that improve internal governance can signal possible pertinent institution-specific requirements for governance improvements. In turn, the implemented institution-specific governance improvements in preemptive remedial measures can help regulators evaluate institution- and industry-specific regulatory needs. Governmental investigations of entity-specific corporate wrongdoing can create feedback effects for industry-specific rulemaking. The feedback process associated with governmental investigations of multiple corporations within an industry for wrongful corporate conduct allows the government to synthesize the information from those multiple investigations and to draw conclusions as to possible industry-specific regulatory needs. In effect, the feedback effects associated with the governmental investigation allow governmental regulators to increase relevant information for rulemaking, culminating in a learning process that increases effective rulemaking. The negotiation of governmental contracts between the corporate wrongdoer and the government can create additional feedback effects for rulemaking. While self-reporting, preemptive remedial measures, and governmental investigations may not always be able to curtail the wrongful conduct, these measures consistently increase the availability of institution-specific information for rulemaking. When the parties enter into negotiations, the government already has a substantial amount of institution-specific information it can use in the negotiations. During negotiations, the government can gain additional information about the corporate wrongdoer and its business practices. Indirect information transfers and feedback effects may exist because the government may be able to deduce from the emphasis of the corporate wrongdoer’s negotiations what particular governance shortcomings need particular remedying. In effect, negotiations between the government and the corporate wrongdoer can provide informational nuances and help distinguish the relevance of identified nuances; that information cannot be attained through mere investigations. Nuances and details attainable through deductive processes in negotiating governmental contracts create feedback effects for rulemaking. The execution of a governmental contract by itself can create feedback effects for rulemaking. The fact that a governmental contract was executed for a specific corporate wrongdoer suggests that the government had sufficient evidence and leverage in negotiations while the corporate wrongdoer was unable to implement sufficient measures to avoid corporate criminal indictment or the execution of the governmental contract. The execution of the > 104 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts governmental contract alone may therefore be seen as a feedback effect that helps regulators identify the intensity, seriousness, and scope of governance shortcomings and the corresponding depth of entity-specific regulatory needs. The respective terms of multiple executed governmental contracts can further direct regulators as to industry-specific regulatory needs. Regulators may receive industry-specific guidance for rulemaking from the quantity of executed governmental contracts pertaining to a particular industry and the quantity of particular (industry-specific) terms in the governmental contracts pertaining to that industry. Most governmental contracts entail specific terms that can create feedback effects for rulemaking by regulators. Such intragovernmental contract feedback effects may include monitoring obligations and reporting obligations. These terms of governmental contracts mandate an increased exchange of information between the corporate wrongdoer and the government that increases the availability of institution-specific information for rulemaking. Should all measures instituted to avoid corporate criminal indictment, including preemptive remedial measures and the unsuccessful negotiation of a governmental contract or plea agreement, prove unsuccessful, continuing corporate wrongdoing and the eventual corporate criminal indictment can create additional feedback effects for rulemaking. Continuing corporate wrongdoing despite the implementation of measures intended to avoid a corporate criminal indictment could suggest that the corresponding institutionspecific governance shortcomings are particularly acute. The corporate criminal indictment reinforces the need to institute appropriate regulatory measures. A feedback effect may be associated with a corporate criminal indictment because the indictment signals to regulators that all possible measures to avoid the indictment were unsuccessful and, thus, underscores the gravity of the offense. Regulators can draw conclusions based on the causes of the indictment and cross-compare and triangulate with other corporate wrongdoers in the same industry to identify appropriate regulatory solutions for the respective industry. In effect, the corporate criminal indictment could solidify the multilevel feedback processes associated with selfinvestigation, self-reporting, preemptive remedial measures, negotiation of governmental contracts, continuing wrongdoing, and execution of governmental contracts between the corporate wrongdoers in the respective industry and the government. # **3. Ex-Ante Experimentation** Governmental contracts enable ex-ante experimentation with regulatory solutions within the theoretical framework of dynamic regulation. In the theoretical framework of dynamic regulation, feedback effects enhance institutionspecific information for rulemaking and allow for institution-specific ex-ante © Stämpfli Verlag AG Bern WULF A. KAAL experimentation before the public rulemaker acts<sup>105</sup> . Governmental contracts can enable dynamic regulation by facilitating multilevel feedback processes that enhance the availability of institution-specific decentralized information for rulemaking. Based on the improved information for rulemaking, regulatory necessities for specific institutions can be more readily ascertained. Tailoring regulatory solutions to ascertainable regulatory necessities via governmental contracts and observing how these regulatory solutions function over time in governmental contracts allows rulemakers to anticipate regulatory demands and engage in institution-specific ex-ante experimentation with regulatory solutions. Furthermore, preemptive remedial measures in combination with other feedback effects associated with governmental contracts, and negotiations between the government and the corporate wrongdoer, allow for experimentation to determine what institution-specific rules are best tailored to the entity and best adjusted for the respective constituents. Governmental contracts therefore exemplify ex-ante experimentation in the framework of dynamic regulation and can help facilitate the anticipation of future contingencies for rulemaking. Several key characteristics of governmental contracts facilitate ex-ante experimentation with regulatory solutions and allow the government to gain significant substantive insights into entity-specific regulatory problems that can often be transferred to the entity’s competitors and the respective industry. Such transferability of knowledge gained via governmental contracts constitutes a key building block for anticipatory dynamic regulation and can enable it. Investigating corporate wrongdoing in specific cases and negotiating contractual terms for the specific wrongdoer in governmental contracts allows the government to enhance its understanding of regulatory issues that can arise in certain industries. Investigations help the government determine the entity- and industry-specific regulatory problems and the particular pressure points of certain industries, and they often provide leverage for negotiations with corporate wrongdoers. Similarly, the government increases its entity-specific knowledge during negotiations of the terms of governmental contracts. Entity-specific knowledge can often be transferred to the respective industry. Moreover, the terms of governmental contracts provide examples and guidance on industry-specific regulatory issues and corresponding regulatory solutions. The entity- and industry-specific knowledge gained during investigations and contract negotiations can be shared with other regulators, allowing regulators to experiment with industry-wide regulatory solutions. Governmental contracts also allow for the quantification of governance > 105 KAAL, W. A. (2014). Evolution of law: dynamic regulation in a new institutional economics framework. In W. A. Kaal, A. Schwartze, & M. Schmidt (Eds.), Festschrift zu Ehren von Christian Kirchner (pp. 1211-1227). Tübingen, Germany: Mohr Siebeck. © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts trends<sup>106</sup> . Identifying more nuanced governance-related trends through data allows regulators to experiment ex-ante with regulatory solutions. Three mutually reinforcing core phases of governmental contracts increase the quality and quantity of institution-specific information and the corresponding extent of transferability of insights. In phase one, before the execution of a governmental contract, self-reporting and voluntary disclosures by a corporate wrongdoer as well as governmental investigations of corporate wrongdoing in the specific case allow for the accumulation of institutionspecific information and a learning process for the government. Building on the information gathered in phase one, in phase two the government further increases its knowledge of corporate governance shortcomings by negotiating contractual terms for the specific wrongdoer in a governmental contract. Finally, in phase three, the executed governmental contract frequently facilitates increased disclosure, significant cooperation with the government, and enhanced compliance<sup>107</sup> . The three identified phases combined advance the government’s ability to assess institution-specific governance issues. Because the information produced in each phase is reinforced or amended in the following phase(s), the quality of institution-specific information can be assumed to be comparatively high. High-quality information about governance challenges pertaining to a corporate wrongdoer can increase the ability of the government to transfer such knowledge to the assessment of the entity’s main competitors or the entity’s industry at large. In effect, the three phases of governmental contracts enable the government/regulator to deductively trace the course or derivation of a single instance of self-reporting, investigation, contract negotiation, and term enforcement and identify possible governance challenges faced by the respective industry. # **4. Facilitating Anticipatory Rulemaking** Governmental contracts can facilitate the anticipation of future contingencies and enable adaptable rulemaking. The government executes governmental contracts with corporate wrongdoers typically after a prior investigation of corporate wrongdoing and/or self-reporting or if preemptive remedial measures instituted by the corporate wrongdoer failed. Investigation, selfreporting, and preemptive remedial measures facilitate anticipation of future contingencies for rulemaking because the government by investigating additional institutions in the same industry can pinpoint more precisely the exact need for regulation. Should, for instance, identified questionable corporate > 106 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. > 107 KAAL, W. A., & LACINE, T. (in press). The effect of non-and deferred prosecution agreements on corporate governance: Evidence from 1993-2013. The Business Lawyer. © Stämpfli Verlag AG Bern WULF A. KAAL practices find multiple applications in a given industry, the rulemaker can tailor rules precisely to such practices and adjust rules accordingly. Should future examinations and investigations in the identified industry produce different emphases necessitating a dynamic adjustment of rulemaking, rulemakers can timely adapt to such contingencies; such adaptations become an integral part of the rulemaking process in a dynamic framework. Multilevel feedback processes associated with the respective phases of governmental contracts can further clarify the scope and fine tuning of required rulemaking. The learning and information enhancement process that is built into governmental contracts makes the dynamic anticipation of future contingencies possible for rulemaking. The transferability of knowledge gained via governmental contracts and the associated feedback effects facilitate a learning process. As governmental regulators investigate corporate wrongdoing and negotiate governmental contracts, they not only obtain information pertaining to particular corporate wrongdoing, they also increase their general familiarity with the industry. Government regulators can also contrast and compare their findings from the three phases of governmental contracts with general market trends pertaining to the respective industry of the investigated entity. The ability to contrast existing information from governmental contracts with otherwise available general information and market trends can enable the anticipation of future contingencies in such industries. # **5. Backward-Looking Ex-Ante Governance** Dynamic regulation via governmental contracts exemplifies corporate governance as a backward-looking endeavor in the theory of dynamic regulation. Dynamic governance structures involving governmental contracts are backward-looking because multilevel feedback effects associated with governmental contracts necessitate an exchange of information pertaining to past events to anticipate future regulatory contingencies. Governmental contracts themselves can also be seen as backward-looking governance because the government investigation of corporate wrongdoing requires the investigation and analysis of past corporate conduct. The government investigates institution-specific past events and assigns liability for such past events in governmental contracts. The backward-looking analysis associated with governmental contracts permeates most phases pertaining to governmental contracts including self-investigation, self-reporting, preemptive remedial measures, negotiation of governmental contracts, continuing wrongdoing, and the execution of governmental contracts. In each phase, the investigation and analysis of past events enable and necessitate future regulatory outcomes. Corporate governance structures involving governmental contracts also embody an ex-ante endeavor because the multilevel feedback effects associated with governmental contracts increase the availability of relevant insti- © Stämpfli Verlag AG Bern Dynamic Regulation via Governmental Contracts tution-specific information for rulemaking before rulemakers act. The ex-ante regulation in governmental contracts can help minimize ex-post trial-anderror experimentation with stable and presumptively optimal rules. Unlike stable and presumptively optimal and forward-looking governance structures, the use of multilevel feedback effects associated with governmental contracts in dynamic governance structures allows the constant and timely evaluation of past and present regulatory solutions. Based on the analysis of multilevel feedback effects involving past and present regulatory solutions and enhanced information for rulemaking, governmental contracts can help identify future regulatory solutions for anticipatory ex-ante rulemaking. # **V. Conclusion** The theory of dynamic regulation suggests that dynamic processes can be included in the rulemaking process via a variety of feedback processes that facilitate a sequence of mutually-reinforcing information-enhancing events to improve the availability and quality of information for ex-ante rulemaking. This process can help minimize ex-post trial-and-error experimentation with stable and presumptively optimal rules, making ex-ante experimentation with regulatory options the focal point of rulemaking in a dynamic framework. Anticipation of future contingencies and adaptability to such contingencies become part of the rulemaking process. The author shows that governmental contracts can enable dynamic regulation by facilitating a combination of multilevel feedback processes that enhance the availability of relevant, institution-specific, and decentralized information for rulemaking. By evaluating regulatory necessities for specific institutions, governmental contracts can enable institution-specific ex-ante experimentation with regulatory solutions. The dynamic process of ex-ante experimentation with institution-specific regulatory solutions enables anticipation of future contingencies for rulemaking in specific industries. Adapting rules to such identified future contingencies becomes possible. © Stämpfli Verlag AG Bern © Stämpfli Verlag AG Bern