A Reputational Theory of Corporate Law

How does corporate law matter? This Article provides a new perspective on the long-standing question by suggesting that the main impact of corporate law is not in imposing sanctions, but rather in producing information. The process of litigation or regulatory investigations produces information on the behavior of defendant companies and businessmen. This information reaches third parties, and affects the way that outside observers treat the parties to the dispute. In other words, litigation affects behavior indirectly, through shaping reputational sanctions. The Article then explores how exactly information from the courtroom translates into the court of public opinion. By analyzing the content of media coverage of famous corporate law cases we gain two sets of insights. First, we learn that judicial scolding does not necessarily hurt the misbehaving company’s reputation. The reputational impact of litigation depends on factors such as who the judge is scolding, what she is scolding them for, and how her scolding compares to the preexisting information environment. Second, we flesh out the ways in which information flows from the courtroom get distorted. Information intermediaries selectively disseminate certain pieces of information and ignore others. And the defendant companies produce smokescreens in an attempt to divert the public’s attention. Recognizing that corporate law affects behavior by facilitating reputational sanctions carries important policy implications. The Article reevaluates key doctrines in corporate and securities laws according to how they contribute to information production. In the process we refocus timely and practical debates such as the desirability of open-ended standards and liberal pleading mechanisms, and the proper scope of judicial review of the Securities and Exchange Commission’s actions. * John M. Olin Corporate Governance Fellow, Harvard Law School. Thanks for helpful comments and discussions go to Jennifer Arlen, Robert Clark, Charles Elson, Tamar Frankel, Howell Jackson, Renee Jones, Kobi Kastiel, Vic Khanna, Edward Rock, Mark Roe, Steve Shavell, Batia Wiesenfeld, and seminar participants at Harvard Law School, Yale Law School, the Corporate Governance Fellows lunch group, and the First Annual Corporate and Securities Litigation Workshop. Financial support was provided by the John M. Olin Center for Law, Economics and Business. Feb. 2014] A Reputational Theory of Corporate Law 1 A REPUTATIONAL THEORY OF CORPORATE LAW