Re-Examining the Business Judgment Rule from a Comparative Perspective: Is it Really in the Shareholders’ Interests?

Many jurisdictions have implemented, or are planning to implement, the business judgment rule as a way to improve their corporate governance practices. In my paper, however, entitled “The Law and Economics of the Business Judgment Rule: Notes for its Implementation in Non-US Jurisdictions” (available here), I argue that the implementation of the business judgment rule in many non-US jurisdictions may actually exacerbate, under some circumstances, the misalignment of incentives between managers and shareholders.

The business judgment rule, as it has been traditionally understood, seems to assume that (i) the main role of the corporation is to maximize the value of the firm; and (ii) shareholders are risk neutral and therefore they do not want their managers to be risk averse. However, these assumptions might not work in many jurisdictions outside the Unites States and even in many US corporations. On the one hand, there are jurisdictions with many family businesses and concentrated ownership structures where shareholders do have incentives to be risk averse, since most of their wealth (including human capital) is invested in the family business. Therefore, they are not diversified, or, at least, in the way traditional finance predicts. On the other hand, there are jurisdictions where the main role of the corporation is not exclusively identified with the interest of the shareholders but also with the interest of other stakeholders. Likewise, many corporations may require, depending on their stage or type of business, a more or less risky investment strategy. Therefore, the application of the business judgment rule may encourage the directors to bear a level of risk that, in some circumstances, might not be desired by the shareholders. Finally, directors in many jurisdictions are not subject to a credible threat of being sued for a potential breach of the duty of care. Therefore, the implementation of the business judgment rule may encourage the directors to ‘over-request’ expert opinions in order to make sure they will be fully protected from a potential –though likely non-existent– lawsuit. On the basis of this exercise, we draw conclusions about the most efficient way to implement (if so) the business judgment rule across jurisdictions, taking into account the divergences in corporate ownership structures, the level of enforcement of the duty of care, and the main role of a corporation in several jurisdictions.

Aurelio Gurrea Martínez is a SPILS Fellow at Stanford Law School and an Executive Director of the Ibero-American Institute for Law and Finance. He also holds a Master’s degree in Law and Finance from the University of Oxford.