Reputation Through Litigation: How the Legal System Shapes Behavior by Producing Information
60 Pages Posted: 20 Oct 2016
Date Written: October 18, 2016
The law affects our behavior not only directly by imposing legal sanctions, but also indirectly, by providing information that shapes the reputations of individuals and organizations. This Article is the first to fully flesh out the reputation-shaping aspects of the law.
The Article’s first major contribution is in explaining how reputation works. Legal scholars are increasingly recognizing that reputation matters. Yet so far the literature has stayed remarkably silent on how exactly reputation matters. This Article draws from a fast-growing multidisciplinary body of reputation research to examine why similar behaviors lead to different reputational outcomes. A key takeaway is that reputational sanctions are much noisier than was previously acknowledged: the market systematically under-reacts to certain types of misbehaviors and over-reacts to others.
The Article’s second major contribution comes from mapping out the different ways in which the law affects reputational sanctions. In the process of finding out whether to impose legal sanctions, the legal system produces as a byproduct information on the behavior of the parties to the dispute: what top managers knew and when they knew it, whether the adverse action was an isolated mistake or whether it is indicative of the company’s operational culture, and so forth. This information reaches third parties, and makes them reassess their beliefs about the company. Contrary to the common assumption among legal scholars, law and reputation are not independent of each other, but rather complement each other. A well-functioning legal system reduces noise and increases the accuracy of reputational sanctions.
Acknowledging the informational role of the law generates important policy implications. First, the Article calls for a more cautious approach to scaling back legal intervention. If the law indeed complements non-legal sanctions, then any proposal to scale back legal intervention should also take into account the expected negative impact on non-legal deterrence. Second, the Article reassesses practical and timely debates such as the desirability of heightened pleading standards. If litigation indeed generates quality information on the behavior of market participants (a positive externality), then we should reevaluate key legal institutions according to how they contribute to information production.
Keywords: Reputation, Litigation, Corporate Law, Corporate Governance, Law and Social Norms, Court of Public Opinion, Pleading Standards, Opennes of Proceedings, Trial versus Settlement, Business Law, Expressive Law
JEL Classification: D80, D83, K13, K20, K22, K40
Suggested Citation: Suggested Citation