Tuesday, November 29, 2022

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C. Empathic Approaches in Corporate Governance

The power and importance of empathic understanding is demonstrated by the observation that empathy may be the basis of some fundamental corporate governance principles. Certain corporate governance rules may have emerged because of the role empathy plays in the processes of corporate decision making. I offer several examples.

First, the Delaware Supreme Court explicitly acknowledged the role empathy plays when special committees of the board of directors are formed in order to determine whether derivative litigation alleging directorial or managerial wrongdoing that harmed the corporation should go forward. The Court held that substantive review of a special litigation committee decision to prevent such litigation is necessary, because committee members will empathize with the directors or officers whose conduct is challenged. "[W]e must be mindful that directors are passing judgment on fellow directors in the same corporation . . . . The question naturally arises whether a 'there but for the grace of God go I' empathy might not play a role." Professor Donald Langevoort describes what I have labeled empathy as an "'in-group' bias that colors how [directors] evaluate claims by others (such as derivative lawsuits brought by shareholders) that threaten one or more group members." Second, empathy may preclude board members, even outside directors who are not employed by the company, from adequately monitoring the conduct of chief executives because they too are senior officers.

Third, judicial justifications of the business judgment rule tacitly describe empathic understanding of the difficulties of corporate decision making. Courts explain that they defer to the business decisions made by corporate boards under the business judgment rule, because they cannot reproduce the exigencies of boardroom decision making in the courtroom. This illustrates unexpressed empathy for corporate officers and directors. Moreover, the very basis for the creation of the business judgment rule is to resolve the problem in large publicly held companies that those who own the company, the shareholders, are not the ones who manage the company. In other words, the business judgment rule is necessary because directors and managers cannot be expected to empathize sufficiently with shareholders.

Another example of corporate governance rules implicitly aimed at inspiring empathy is found in the Securities Act of 1933. Section 77k imposes liability for materially misleading statements or omissions in registration statements. The section also provides what is called the "due diligence" defense, which is available to any defendant who conducted a reasonable investigation about the truthfulness of registration statement materials. The Act defines reasonable investigation as requiring a level of reasonableness that "a prudent man" would apply "in the management of his own property." This standard inspires empathy for shareholders, or potential shareholders, who may rely on a registration statement by requiring defendants to manage shareholders' affairs in the same way they would manage their own.

Even the most mundane corporate governance issues implicitly recognize the importance of empathy, or aligning the interests of the decision maker with the interests of the group for whom decisions are made, as a way to resolve the separation of ownership and control problem. For example, some companies provide corporate managers with stock options. This aligns the manager's personal wealth with that of shareholders. It fosters a manager's identification with the company. Robert Hamilton writes:
The National Association of Corporate Directors has recommended that a significant portion of each director's compensation should be paid in the form of stock in the corporation rather than in cash. This recommendation, designed to align the economic interest of directors more closely with those of the shareholders, has been widely adopted.

[a1]. Dean Harold F. McNiece Professor of Law, St. John's University School of Law. I would like to thank Professors Martha Fineman, Martha McCluskey, and Dalia Tsuk for planning and executing the Workshop on Feminism, Corporations, and Capitalism, sponsored by the Baldy Center for Law & Social Policy and the Feminism and Legal Theory Project, at which an earlier draft of the Essay was presented.