Home -> Law Blog Directory -> Corporate Governance Blogs -> The Harvard Law School Corporate Governance Blog

Corporate Governance

: The Harvard Law School Corporate Governance Blog

How Important is Private Enforcement for Corporate Law?

By Harvard Law School Program on Corporate Governance

It is often assumed that strong securities markets require good legal protection of minority shareholders. This implies both ?good? law — principally corporate and securities law — and enforcement, yet there has been little empirical analysis of enforcement. In our paper entitled Private Enforcement of Corporate Law: An Empirical Comparison of the UK and US, Bernard S. Black, Brian R. Cheffins, Richard Nolan and I study private enforcement of corporate law in two common law jurisdictions with highly developed stock markets, the United Kingdom and the United States, examining how often directors of publicly traded companies are sued, and the nature and outcomes of those suits.

We find, based a comprehensive search for filings over 2004-2006, that lawsuits against directors of public companies alleging breach of duty are nearly nonexistent in the UK. The US is more litigious, but we still find, based on a nationwide search of decisions between 2000-2007, that only a small percentage of public companies face a lawsuit against directors alleging a breach of duty that is sufficiently contentious to result in a reported judicial opinion, and a substantial fraction of these cases are dismissed. Our findings also suggest that the risk that directors would pay out of pocket, for anything other than improperly putting money in their own pockets to begin with, was negligible ? we found no such cases over an 8-year period. The upshot is that while directors of publicly traded US companies are much more likely to be sued under corporate law than their British counterparts, lawsuits under corporate law are hardly an everyday occurrence and out-of-pocket liability is scarcely to be feared.

The UK has strong substantive corporate law, but, almost no formal private enforcement of that law against directors of publicly traded companies. The absence of formal private enforcement highlights the importance of procedural rules, often general rules not limited to corporate cases, for the practical operation of substantive rules. Differences in general rules governing class actions, contingency fees, and who pays the winner?s legal expenses, in tandem with specific rules regarding the availability of derivative actions and direct claims in corporate law, may do much to explain the large differences in levels of private enforcement.

We examine possible substitutes in the UK for formal private enforcement of corporate law and find some evidence of substitutes, especially for takeover litigation. Nonetheless, our results suggest that formal private enforcement of corporate law is less central to strong securities markets than might be anticipated. The lack of formal enforcement in the UK ? and its robustness in the US despite relatively ?weak? corporate law rules — also highlights the potential gap between law in books and law in action, which has been understudied in law-and-finance studies of the underpinnings of strong securities markets. US corporate and securities law is often thought of as being highly protective of outside investors. At least for corporate law, this is not because the substantive law is strong ? by international standards it is not. One possible inference is that corporate law is not a key determinant of stock market development. Another is that the intensity of formal private enforcement compensates for the modest formal protections substantive law offers, producing a ?shareholder-friendly? end result.

The paper is available here.

Full post as published by The Harvard Law School Corporate Governance Blog on April 30, 2009 (boomark / email).