Maybe courts trust investors and capital markets and the judicial deference to directors is more a symptom of that than trust in them as such. Investors and markets ought to be skeptical of directors and often are.

In two recent articles on good faith in Delaware, Claire Hill and I argue that the Delaware courts are at least inching in the direction you suggest. There are a variety of types of cases that fall in between fairness and bjr review, including Unocal and Revlon, Zapata, and the emerging good faith jurisprudence. We think all of these cases can be linked to structural bias concerns of the kind you mention. The courts are still largely reluctant to hold directors liable, but they are providing somewhat more searching scrutiny that may have the effect of changing norms and best practices.

I do not know why, as you assert, "courts trust directors so much that they're willing to ignore all but the most egregious conflicts of interest," but I will argue that such a posture is in fact pretty reasonable, given the situation under consideration.

I know no-one connected with or observing boards in action who would plausibly deny the sorts of structural and psychological biases you identify, and I would presume most judges would not argue too strenuously with you about it either. However, everyone involved, upon a little reflection, should develop a healthy respect for the difficulty of board members' duties. The essence of business--whence presumably comes the business judgment rule--is decision-making under uncertainty. Almost never does a board have in its possession the complete set of facts it would like when it makes a decision (and which may turn up in hindsight and/or legal discovery). In many cases, had they had the facts in hand which later turned out to be the case, many directors would admit that they would have decided differently. But this sort of thinking is pointless and completely moot. Boards decide and move on.

Besides, many of the acknowledged biases of corporate boards are structurally inherent in our current system of governance, whereby essentially non-owner directors are both chosen by and oversee powerful professional managers. These biases include, among others, (perhaps excessive) trust in management, the inertia inherent in consensual decision making, and the like. But how would you propose to alter such a system? Governance seems to work much better in companies owned and controlled by private equity firms, but how do you legislate (or adjudicate) that for publicly owned corporations?

Few decisions in business--or in life--can withstand second-guessing very well. Unless the fact pattern in a particular case is indeed so egregious as to call into doubt whether a reasonable person would have decided in the same way as the board in question, why indeed should a court not defer to the people who were on the scene at the time?

Finally, let us not forget why this existential question arises in the first place: some plaintiff argues that they have suffered an injury resulting from the board decision(s) in question. But business is all about making choices, many of which have zero-sum outcomes, and it is rare that some party's ox does not get gored. Is it the court's role to pick winners and losers in business situations retrospectively? Again, unless reasonable business judgment has been obviously violated, I would argue no. Presumably, many (most?) judges would agree with me.

Anyway, that's my two cents worth, from the perspective of a (non-legal) advisor to boards.

Lawrence:

Maybe. But given that shareholders rights are so limited, both in terms of voting and selling (at least with respect to hostile takeovers), I would say that trust in investors and capital markets is misplaced. Not as a matter of principle, but as a matter of fact.

Brett:

I'll take a look at your articles, but I must say I'm pretty skeptical. I believe (and have argued) that the existing standards of review have been watered down to near meaninglessness, and I have yet to be persuaded that there is an emerging good faith jurisprudence that is worth much. But I hope you are right.

Epicurean Dealmaker:

All your arguments sound more like reasons that we should have a business judgment rule -- a proposition with which I agree whole-heartedly -- as opposed to why it should be relied on so heavily.

When a board is conflicted, the concern is not about incomplete information, imperfect decisions, or second-guessing; rather, it's that there will be a tendency on the part of directors to favor their own interests over those of the shareholders. And because such conduct may not even be conscious, I have a hard time seeing how blind trust in directors could be considered "reasonable" under the cirucmstances.

You ask for comments about: "...why courts trust directors so much that they're willing to ignore all but the most egregious conflicts of interest." I am not convinced of the premise of your question. Here are a few links to a few recent Delaware cases that rebut the premise in your question.

http://www.delawarelitigation.com/2007/09/articles/chancery-court-updates/stock-option-claims-allowed-to-proceed-and-dgcl-section-327-addressed/ ; http://www.delawarelitigation.com/2007/08/articles/chancery-court-updates/excessive-executive-compensation-looting-claim-allowed-to-proceed/ ; http://www.delawarelitigation.com/2007/08/articles/chancery-court-updates/chancery-gives-second-chance-to-springloading-claim/

I would like to supplement my comment of a few minutes ago to say that I commend your work and appreciate your discussion. Your topic is interesting. I only provided a few recent cases at my fingertips, but I will try to make time to find a few more that may be more on point. Thanks.

Francis:

Thanks for the reminders. However, I take "a few recent Delaware cases" to be more anecdotal than illustrative. I'll wait to see the final resolution -- after trial and appeal -- before I get excited. We've been down this path before. Remember Disney?

I do think that the Court of Chancery is much "better" in this respect than the Supreme Court. However, I am quite convinced of my premise. Of course, I would be quite happy to see things change.

From a brazilian lawyer perspective it is wonderful to see that a such a discussion is even possible. Although corporate law in Brazil (Lei das Sociedades Anonimas) has a chapter dealing with fiduciary duties (that was drafted based in the US system) the judges simply lack the power to challenge the big business and the corporate private sector is so commingled with the public government sphere that big corporate issues turns out in the end as political issues.

To understand 'why we trust directors' I think we need to consider the alternative. Compared to the first-best (i.e. informed unbiased decisions), directors may be a huge failure for the reasons mentioned above, but compared to ex post review by a state court judge, director decisions may not look so bad. The alternative question seems just as relevant: 'why should we trust judges?' Judges have limited information, lack of business experience, and are also susceptible to various professional biases. I do not mean this as a blanket defense of the business judgment rule. Some form of intermediate review is probably be desirable.

But, I think we should also be skeptical of judicial capacity. In the language of Lon Fuller, review of board decisionmaking is likely to be a 'polycentric problem', poorly suited to adjudication. This effectively becomes a comparative question as to the best decisionmaker: judge or director.

Julian,

I do quite a bit of work in conflicts of interest as they pertain to clinical practice and clinical research, and though I have absolutely no expertise about corporate law, my own answer to your question is that "we" tolerate absolutely astonishing conflicts of interest generally.

There is no shortage of articles and books addressing and even quantifying the extent of these conflicts in clinical practice and clinical research. As to why we tolerate them as much as we do, I suspect the answer is complicated. One plain reason is because we continue to believe in a patently absurd and oversimplified notion of conflicts of interest (e.g., that they only matter if the stake is of high value, which is simply untrue). We think conflicts can generally be managed retrospectively, which is also dubious, frankly, as many scholars have pointed out. We also deny the extent of the subconscious influence they have, and presume that because the individual facing the conflict is virtuous, the effects of the conflict are negligible. This, too, is a dubious proposition.

So, without knowing much of anything about the specific question you're asking, I would suggest that one plausible answer to 'why do we tolerate this situation' is because we permit and sanction -- even endorse, in many instances -- extensive and wide-ranging conflicts of interest across huge swaths of commercial and even "morally" eleemosynary institutions (like medical practice).

JMO.