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Allen on Modern Corporate Governance

In a paper entitled Modern Corporate Governance and the Erosion of the Business Judgment Rule in Delaware Corporate Law, former Delaware Chancellor William Allen tackles two subjects near to my heart: (1) the role of the board of directors and (2) the centrality of the business judgment rule to corporate law.

As to the former, he opines that:

In 1985 – in the famous Van Gorkom, Revlon and Unocal cases – the Delaware courts in responding to these enormously significant transactions began a process of modification of their interpretation of corporate directors’ fiduciary duties. The focus of these legal changes were two ideas. First, in these cases the Delaware Supreme Court made it very clear that it took very seriously the formal allocation of ultimate corporate power to the board of directors. It did not adopt the “realistic,” view of the academic community at that time which saw boards as inevitably passive. In these change of corporate control cases, the Delaware Supreme Court demanded to see board engagement, not the CEO domination that Professor Galbraith had noted.

In other words, although he does not say so explicitly, Delaware embraced director primacy.

As to the second, he notes:

The second thrust of these opinions was the willingness of the Delaware Supreme Court to push the business judgment rule aside in order more actively to review board engagement in these cases.

Allen explains that:

As you know, the business judgment rule is the doctrinal technique used by courts to protect directors from the risks they would face were juries permitted to answer the question: “did this director when he approved this loss making transaction act as a reasonable person in the same or similar circumstances would have acted?”

This is quite close to the conception of the BJR that I advanced in The Business Judgment Rule as Abstention Doctrine, which argues that “Because one cannot make directors more accountable without infringing on their exercise of authority, courts must be reluctant to review the director decisions absent evidence of the sort of self-dealing that raises very serious accountability concerns.” I thus also agree with Allen that there are strong policy justifications for the rule.

Hence, I share Allen’s concern that the cases mentioned, plus more recent ones like Disney, pose a serious threat:

This tendency for courts to be willing to second guess board decisions or processes when there is no financial conflicting interest, which is sometimes encouraged by corporate governance commentators, is I think worrying and likely in the end not to be beneficial to investor interests.