The End of Contractarianism?: Behavioral Economics and the Law of Corporations

Abstract

For a generation, the law of corporations depended on, and sprang from, a notion of economic rationality. This rationality took as its touchstone the efficiency of the marketplace (especially the securities market) and the predictability of the utility-maximizing behavior of the various actors. These assumptions undergirded both the doctrinal innovations and the academic conceptualizations of the field, leading to a prioritization of contractarian reasoning in chancery courts and corporate law classrooms. The judicial enforcement of traditional fiduciary duties melted away, as markets themselves came to be seen as the primary method of keeping management careful and loyal. Disclosure was vested with the mantle of favored regulatory mechanism, since the dominant assumption was that investors armed with information needed no other protection from corporate negligence or malfeasance.

Behavioral economics began to be taken seriously in the legal academy in the last decade of the twentieth century, and by the early 2000s was beginning to gain traction in corporate law scholarship. Though corporate and securities law was perhaps the last bastion in the legal academy of the assumptions of neoclassical economics, it is safe to say that the global financial crisis of 2007–8 finally marked the end of the glory days of homo economicus. The evidence of the persistence and ubiquity of so-called irrationalities is so pervasive, replicable, and defensible that the primary debate is no longer between behaviorists and those who would defend a more traditional position. Instead the debate is over what to do with, and about, the spoils of victory.

This chapter will offer some thinking in that regard in connection with corporate and securities law. To begin, the chapter will describe some of the ways in which economic rationality influenced corporate law doctrine and scholarship during its heyday. This backward nod is helpful in defining possible implications for the weakening of the rationality assumptions later. Section 2 focuses on the difficulty of developing behavioral research in the area of corporate governance, arguing that the main behavioral innovation is a move away from libertarianism toward regulatory “agnosticism.” In section 3, I will discuss what I believe to be the most profound potential implication of behavioral scholarship on corporate governance: using insights on the decision-making of groups to bolster the argument that board homogeneity is a danger, and that increased board diversity of various kinds is likely to improve board performance.