Title: Cost-Benefit Analysis of the Business Judgment Rule: A Critique In Light of the Financial Meltdown
Abstract: In 2008, the United States--indeed the whole world--suffered a devastating financial meltdown. We know now that a significant cause of the meltdown was that, in the face of numerous red flags, the managers of several venerable financial firms decided to take tremendous risks in the subprime mortgage market, and the directors of these firms did little or nothing to stop them. However, despite their actions, these managers and directors face little or no risk of personal liability because they are shielded by the business judgment rule and other liability-reducing mechanisms, such as director exculpation statutes. Given the magnitude of the recent financial meltdown, this article calls for a reexamination of the arguments for and against shielding corporate managers and directors from virtually all personal liability. After providing background on the business judgment rule and director exculpation statutes, this article recasts the prominent arguments for and against the business judgment rule as cost-benefit arguments. On one hand, most pro-business judgment rule arguments focus on the benefits of shielding directors from liability risk, namely enhancing shareholder wealth. On the other hand, most critiques of the business judgment rule endeavor to show that the costs of shielding directors from liability risk are greater than generally assumed. Instead of entering this debate, this article rejects the cost-benefit framework altogether. Drawing upon arguments developed by critical legal scholars, the article claims that cost-benefit analysis is indeterminate. Because cost-benefit analysis is indeterminate, it is impossible to determine whether the costs of increasing directors' liability risk outweigh the benefits. Cost-benefit analysis can just as readily lead to the conclusion that the benefits outweigh the costs. Therefore, due to their reliance on cost-benefit analysis, the pro-business judgment rule arguments fail to justify the rule. I. INTRODUCTION In the summer of 2008, the United States suffered a spectacular financial meltdown. Since then, Americans collectively have lost trillions of dollars, (1) and millions have lost their jobs (2) and their homes. (3) Additionally, incalculable damage was inflicted on both the global economy (4) and the public's confidence in the future of and trust in the financial system. (5) The causes of this disaster are now fairly well understood. One of the most significant causes was that, in the face of numerous red flags, (6) the managers of several large and venerable financial firms decided to take on tremendous amounts of risk in the subprime mortgage market, and the directors of these firms did little or nothing to stop them. (7) However, even though they exercised such little caution in exposing their firms to such high levels of risk, the managers and directors responsible for the decisions that led to the financial meltdown will probably not suffer any personal liability. (8) While directors technically owe a fiduciary duty to exercise care in making business decisions, the business judgment rule and director exculpation statutes almost entirely shield directors from risk of personal liability for breaching that duty. (9) Typically, the business judgment rule and director exculpation statutes are defended with the same battery of policy arguments. (10) The following are three of the most frequently recurring policy arguments: (1) if directors' liability risk were increased, directors would be overly deterred from taking entrepreneurial risks; (11) (2) if directors' liability risk were increased, current directors and director candidates would be overly deterred from serving as directors; (12) and (3) market mechanisms, namely the market for capital and the market for corporate control, already provide sufficient incentives for directors to exercise care. (13) Fundamentally, all three of these arguments employ a cost-benefit framework. …
Publication Year: 2010
Publication Date: 2010-09-22
Language: en
Type: article
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Cited By Count: 4
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