Directors’ and Officers’ Liability: Economic Analysis

Forthcoming in: Simon F. Deakin/Helmut Koziol/Olaf Riss, eds., Directors & Officers Liability, Tort and Insurance Law Series, vol. 36, Berlin (de Gruyter), 2017

European Corporate Governance Institute (ECGI) - Law Working Paper No. 376/2017

47 Pages Posted: 26 Oct 2017 Last revised: 7 Jan 2018

Patrick C. Leyens

Erasmus University Rotterdam (EUR) - Rotterdam Institute of Law and Economics; Humboldt University of Berlin - Faculty of Law; Max Planck Institute for Comparative and International Private Law

Michael G. Faure

University of Maastricht - Faculty of Law, Metro; Erasmus University Rotterdam (EUR) - Erasmus School of Law

Date Written: January 1, 2018

Abstract

This paper will be published as a chapter of the forthcoming volume ‘Directors & Officers Liability’ edited by Simon F. Deakin, Helmut Koziol, and Olaf Riss. It explores D&O liability from a law and economics perspective with a view to identify trade-offs of different legal settings. The paper is organised along the general structure of the edited volume.

Limited shareholder liability marks the starting point for understanding the rationale of outside D&O liability towards creditors where the delegation of decision making is misused by owners. In turn, inside liability towards the corporation protects owners against misbehavior of their agents. Outside and inside liability inter-act in that they both serve to reduce the overall costs of firms with delegated management.

Inside liability is shaped by the duty of loyalty which protects the corporation against stealing and the duty of care that prevents shirking by agents. The differences between these types of duties are a result of the limited possibilities to specify rules of behavior ex ante one the one hand and the need for open standards regarding risk taking which concretize only ex post on the other hand. The danger of hindsight by courts can be reduced by procedural tests that serve as abstention rules to preclude second guessing. Internal monitoring can prevent misbehavior but failures of internal monitors seem to be a double mirror of the hindsight problem that inspired abstention from reviewing management decisions.

Outside D&O liabilities to third parties can be seen as a strategy to prevent opportunistic behavior of owners especially in regard to financial disclosure and insolvency. The overall incentive structure depends on the availability of ex ante indemnification, ex post waivers, and insurance covers.

Keywords: Directors, officers, liability, no-conflicts rule, business judgment rule, fiduciary duties, monitoring duties, Caremark, ARAG-Garmenbeck

JEL Classification: K13, K22, K41

Suggested Citation

Leyens, Patrick C. and Faure, Michael G., Directors’ and Officers’ Liability: Economic Analysis (January 1, 2018). Forthcoming in: Simon F. Deakin/Helmut Koziol/Olaf Riss, eds., Directors & Officers Liability, Tort and Insurance Law Series, vol. 36, Berlin (de Gruyter), 2017; European Corporate Governance Institute (ECGI) - Law Working Paper No. 376/2017. Available at SSRN: https://ssrn.com/abstract=3059284

Patrick C. Leyens (Contact Author)

Erasmus University Rotterdam (EUR) - Rotterdam Institute of Law and Economics ( email )

Burgemeester Oudlaan 50
PO box 1738
Rotterdam, 3000 DR
Netherlands

Humboldt University of Berlin - Faculty of Law ( email )

Unter den Linden 6
Berlin, D-10099
Germany

Max Planck Institute for Comparative and International Private Law ( email )

Mittelweg 187
D-20148 Hamburg
Germany

HOME PAGE: https://www.mpipriv.de/en/pub/academic_staff/affiliates/leyens_patrick_c.cfm

Michael G. Faure

University of Maastricht - Faculty of Law, Metro ( email )

PO Box 616
Maastricht, 6200 MD
Netherlands
+31 - 43 - 388 30 60 (Phone)
+31 - 43 - 325 90 91 (Fax)

HOME PAGE: http://www.michaelfaure.be

Erasmus University Rotterdam (EUR) - Erasmus School of Law ( email )

3000 DR Rotterdam
Netherlands

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