September 08, 2008
"Bad Business Judgments and Herd Behavior"
Posted by Lisa Fairfax

This morning, I was listening to C-Span Radio's coverage of the takeover of Fannie Mae and Freddie Mac, which included commentary and  Q&A from callers by Patrice Hill, chief economics correspondent at the Washington Times . As might have been inevitable, several callers asked whether the mortgage crisis involved criminal or fraudulent acts on the part of company officers and directors at Fannie Mae, Freddie Mac, or otherwise. They were particularly interested in knowing about potential SEC or Justice Department investigations, with some expressing concern, and often outrage, over the likelihood that departing executives could receive lucractive exit packages. On this latter point, Hill noted that any exit packages would surely be heavily scrutinized. On the issue of fraud and criminality, although Hill appeared to concede the possibility that some people had engaged in fraudulent or criminal behavior, she also indicated that, as a general matter, it probably was not appropriate to characterize the judgments made in the corporate board room as fraudulent or criminal in nature. Instead, she stated that the current crisis appeared to be the result mainly of “bad business judgments and herd behavior.” And she noted that given the many people who took part in the risky and questionable financial arrangements surrounding the mortgage crisis, characterizing such behavior as criminal would mean that millions of people belong in jail. 

I found Hill’s comments both interesting and disturbing.  To be sure, one of the things corporate fiduciary law does is protect business people from liability associated with bad business decisions. Of course, disagreement exists about how that law is applied and whether it is too lax, especially during times when shareholders and stakeholders appear to bear the brunt of those bad decisions. Nevertheless, there is good reason for ensuring that corporate officers and directors have the flexibility to make business decisions, even if some of them turn out to be bad.  This means that if people in the boardroom were guilty only of making bad business judgments, then they likely not only avoid criminal liability, but also avoid civil liability associated with breaching their fiduciary duty.  However, while it may be acceptable to allow those who made bad business judgments to avoid liability, it seems more problematic as applied to those who engaged in herd behavior. This is because while making a bad business judgment involves actual decision-making, engaging in herd behavior likely does not. To that end, following the crowd and thus falling prey to a herd mentality, as Hill suggests, does not appear to have anything to do with decision-making. And if that is the case, then herd behavior on the part of corporate officials is disturbing and arguably more problematic than making a bad decision. 

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