54 Pages Posted: 20 Aug 2007
Date Written: August 17, 2007
In the United States, federal and state laws envision a variety of roles for management and non-management directors on corporate boards. At bottom, the proper and lawful performance of these roles, and the legitimacy of director decision-making and monitoring turns on the extent to which the directors exercise judgment without being unduly swayed by cognitive bias. A recent empirical study conducted by the Cultural Cognition Project at Yale University suggests that cultural-identity-protective cognition - a type of cognitive bias related to one's cultural worldview - influences risk assessment in the general population. This Article proposes that identity-protective cognition may influence systematically director behavior, including recommendations to dismiss shareholder derivative litigation, decisions regarding executive compensation, and director monitoring of conflict-of-interest transactions.
Generally, courts and regulators assume that directors' risk assessment may be influenced by financial incentives and familial ties. Courts give greater scrutiny to a board's decision-making process if the process may be tainted by financial incentives and familial ties. Alternatively, courts give more deference to a board's decision-making process if the decision was made by directors who are free of financial and familial ties. However, courts and regulators assume that directors' risk assessment would not be influenced (at least not in any way that needs to be addressed by regulation) by other incentives, such as a need to protect one's cultural identity.
While more research is needed to determine the extent of cultural-identity-protective risk assessment on board behavior, and such research should be informed by evidence from directors on their perceptions of their roles and functions, the theory of cultural-identity-protective cognition suggests that changes in corporate governance law and behavior are necessary to promote unbiased decision-making by directors. This Article proposes that such changes should include greater diversity in worldviews on corporate boards. Perhaps this diversity could be accomplished by assuring that directors are educated about different worldviews, and assigning a director (or board committee) the task of "chief naysayer" - someone whose questions would arise from worldviews not represented in the majority of the board. Also, courts may need to account for directors' identity-protective bias when reviewing directors' decisions.
Keywords: corporate governance, board of directors, cognitive bias
JEL Classification: K22
Suggested Citation: Suggested Citation