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
47 Pages Posted: 26 Oct 2017 Last revised: 14 Nov 2017
Date Written: November 1, 2017
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 designs. 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 misbehavour of their agents. Outside and inside liability interact 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 behaviour ex ante the one hand and the need for open standards regarding risk taking which concretise 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 misbehaviour but failures of internal monitors seem to be a double mirror of the hindsight problem that inspires court abstention from reviewing management decisions.
Outside D&O liabilities to third parties can be seen as a strategy to prevent opportunistic behaviour 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, insurance covers, as well as on the design of procedure especially in regard to low value losses.
Keywords: Directors, officers, liability, no-conflicts rule, business judgment rule, fiduciary duties, monitoring duties, Caremark, ARAG-Garmenbeck
JEL Classification: K13, K22, K41
Suggested Citation: Suggested Citation