Corporate Governance and Risk-Taking: A Statistical Approach

Abstract

This Article makes three related claims about risk-taking in corporate governance. Because prudent governance often requires managers to take risks based on statistically expected outcomes, corporate failures that have a small but finite chance of occurring cannot always be prevented. Accordingly, this Article’s first claim is that managers should not automatically be presumed to be at fault for corporate failures that result from risk-taking decisions based on statistical methodologies that reasonably justify the decisions ex ante.

Conceptually, the business judgment rule should protect corporate managers for engaging in a reasonable decisionmaking process, including one that is statistically based. Jurisdictionally, however, the scope of the business judgment rule is narrowly limited (primarily, to state-law shareholder derivative lawsuits), leaving a large protection gap. To fill this gap, this Article’s second claim is that corporate managers should also be protected by a “statistics-based governance” rule that exempts them from liability, under both federal and state law, for making risk-taking decisions based on statistical methodologies that reasonably justify their decisionmaking (assuming good faith, and no managerial conflicts of interest or fraud). Part of the rationale for this claim is that a statistics-based governance rule would be more objective, and thus less subject to criticism, than the business judgment rule.

The Article’s third claim concerns expected-value analysis, which is the statistical methodology most generally accepted and widely used for making risk-taking decisions. When determining an expected value, corporate managers should ask, “Expected value to whom?” For most risk-taking decisions, this determination should only take into account the firm and its investors. However, for decisions that could cause significant economic, environmental, or other social harm, this determination should also endeavor to take into account the public.