Spare the Rod, Spoil the Director? Revitalizing Directors' Fiduciary Duty Through Legal Liability

65 Pages Posted: 7 Oct 2004

See all articles by Lisa M. Fairfax

Lisa M. Fairfax

University of Pennsylvania Carey Law School - Institute for Law and Economics

Abstract

It appears that our society has tacitly agreed to spare corporate directors any significant legal liability - which includes both financial and incarceration - for failing to perform their duties as board members. Thus, over the last twenty years, there has been a virtual elimination of legal liability - particularly in the form of financial penalties - for directors who breach their fiduciary duty of care. This is true despite the fact that we entrust directors with the awesome responsibility of monitoring all of America's corporations as well as the officers and agents within those corporations. More surprisingly, this tacit agreement against legal liability for directors has persisted even reform efforts designed to prevent corporate governance failures. Thus, while Sarbanes-Oxley imposes increased responsibilities on directors, that Act fails to impose any direct legal penalties on directors when they breach those responsibilities.

Most corporate scholars appear to support this failure, not only insisting that other extra-legal measures sufficiently ensure directors' compliance with their fiduciary duties, but also arguing that legal remedies are both costly and ineffective. This Article disagrees. Instead, this Article uses Sarbanes-Oxley and events which led to its enactment to demonstrate that most arguments rejecting director liability inappropriately assess the costs and benefits of legal penalties, while failing to appreciate the degree to which extra-legal market or reputational sanctions depend upon legal measures for their effectiveness. Thus, this Article concludes that legal sanctions represent a vital aspect of any system seeking to regulate director misconduct. As a consequence, this Article also concludes that many of our corporate governance reforms may be defective because they impose new and significant obligations on directors, but make no specific provisions for sanctioning directors' failure to fulfill such obligations.

Keywords: directors, liability

Suggested Citation

Fairfax, Lisa M., Spare the Rod, Spoil the Director? Revitalizing Directors' Fiduciary Duty Through Legal Liability. Houston Law Review, Vol. 42, pp. 393-456, 2005, U of Maryland Legal Studies Paper No. 2004-21, Available at SSRN: https://ssrn.com/abstract=601970 or http://dx.doi.org/10.2139/ssrn.601970

Lisa M. Fairfax (Contact Author)

University of Pennsylvania Carey Law School - Institute for Law and Economics ( email )

3501 Sansom Street
University of Pennsylvania Carey School of Law
Philadelphia, PA 19104
United States
215-746-2243 (Phone)
215-573-2025 (Fax)

HOME PAGE: http://https://www.law.upenn.edu/faculty/fairfaxl

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