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We present a new welfare‐based framework for optimally choosing legal standards (decision rules). We formalise the decision‐theoretic considerations widely discussed in the existing literature by capturing the quality of the underlying analysis and information available to a regulatory authority, and we obtain a precise necessary and sufficient set of conditions for determining when an Economics or Effects‐Based approach would be able to discriminate effectively between benign and harmful actions and consequently dominate per se as a decision‐making procedure. We then show that in a full welfare‐based approach, the choice between legal standards must additionally take into account, (i) indirect (deterrence) effects of the choice of standard on the behaviour of all firms when deciding whether or not to adopt a particular practice; and (ii) procedural effects of certain features of the administrative process in particular delays in reaching decisions; and the investigation of only a fraction of the actions taking place. We therefore derive necessary and sufficient conditions for adopting Discriminating Rules, as advocated by the Effects‐Based approach. We also examine what type of Discriminating rule will be optimal under different conditions that characterise different business practices. We apply our framework to two recent landmark decisions – Microsoft vs. EU Commission (2007) and Leegin vs. PSKS (2007) – in which a change in legal standards has been proposed, and show that it can powerfully clarify and enhance the arguments deployed in these cases.
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