The Impact of Corporate Law on Reputation: A New Perspective, Schemes and Mind Maps of Corporate Law

Download The Impact of Corporate Law on Reputation: A New Perspective and more Schemes and Mind Maps Corporate Law in PDF only on Docsity! 1 A REPUTATIONAL THEORY OF CORPORATE LAW Roy Shapira* How does corporate law matter? This Article provides a new perspective on the longstanding 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 businesspeople. 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 whom 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 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. INTRODUCTION ........................................................................................................... 3   I.   HOW THE LAW SHAPES REPUTATIONAL SANCTIONS: A GENERAL FRAMEWORK ........................................................................................................ 6   * 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, Harvey Pitt, Edward Rock, Mark Roe, Steve Shavell, Andrew Tuch, Batia Wiesenfeld, and seminar participants at Harvard Law School, Tel Aviv University, 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. 2 STANFORD LAW & POLICY REVIEW [Vol. 26:1 A.  Reputational Sanctions: How They Work, and Why They Are Noisy ............. 7   B.   How Litigation Affects Reputation ............................................................... 10   1.   First-Opinion Effects ............................................................................. 11   2.   Second-Opinion Effects ........................................................................ 12   3.   Multiple Layers of Reputation Information .......................................... 13   C.   Applying the General Framework to Specific Legal Fields ......................... 14   II.   CORPORATE LITIGATION’S IMPACT ON NONLEGAL SANCTIONS ......................... 15   A.  Litigation’s Impact on Moral Sanctions: “Saints and Sinners” Revisited ....................................................................................................... 16   B.   Litigation’s Impact on Reputational Sanctions: Towards a Novel Approach ...................................................................................................... 19   1.   Scolding Who? Individual Reputation vs. Organizational Reputation ............................................................................................. 19   2.   Scolding Compared to What? What Information Is Available vs. How It Is Diffused ................................................................................. 21   3.   Scolding for What? Incompetence vs. Immorality ............................... 23   III.  THE DISNEY LITIGATION: A CASE STUDY ........................................................... 24   A.   Information Produced Before Litigation Started ......................................... 26   B.   Information Produced During Litigation ..................................................... 28   1.   The Impact of the Process ..................................................................... 28   2.   The Real Impact of the Verdict ............................................................. 30   a.   Emphasizing the Context. ................................................................ 30   b.   Scolding for Honest and Transient Mistakes. .................................. 32   c.   Scolding Individuals Who Were Already Ousted. .......................... 33   3.   Lost in Translation: Additional Comments on Information Flows ....... 36   a.   Different Types of Intermediaries Cover Verdicts Differently. ...... 36   b.   Companies Affect the Information Flows from the Courtroom. ..... 37   C.   How Generalizable Are the Lessons from Disney? ..................................... 38   IV.  IMPLICATIONS: THE INDIRECT DETERRENCE FUNCTION OF DELAWARE CORPORATE LAW ............................................................................................... 40   A.  How Key Doctrines Contribute to Information Production ......................... 40   1.   Procedural Doctrines: Pleading Mechanisms and Settlements Approvals .............................................................................................. 40   a.   The Pleading Stage. ......................................................................... 41   b.   The Settlement Stage. ...................................................................... 42   2.   Substantive Review: How to Assess Director Liability and the Role of Indeterminacy ........................................................................... 43   a.   Should Director Liability Be Assessed Individually or Collectively? .................................................................................... 43   b.   The Role of Indeterminacy. ............................................................. 44   B.   How the Content of Corporate Law Is Determined: A “Make It Look like a Struggle” Theory ................................................................................ 45   V.  THE REPUTATIONAL CONSEQUENCES OF SEC ENFORCEMENT ACTIONS ........... 48   A.   Judge Rakoff vs. SEC Settlement Practices: The Existing Debate ............... 49   B.   Identifying the Problem: How SEC Settlements Underproduce Information ................................................................................................... 51   C.   Explaining the Problem: Why the SEC Trades Information for Fines ........ 53   D.   Solving the Problem: Can Enhanced Judicial Scrutiny Help? .................... 54   CONCLUSION ............................................................................................................ 56   2015] A REPUTATIONAL THEORY OF CORPORATE LAW 5 market, when left alone, has trouble calibrating reputational sanctions correctly. But in reality the market rarely is left alone. Market players continuously look for information that is being produced by the legal system to help them revise their initial reputational assessments. Reputational sanctions thus operate in the shadow of the law. Part II applies the general framework to corporate fiduciary duty litigation in Delaware. I first refocus the debate over the effectiveness of corporate-law enforcement. When measuring enforcement we should look not just at the outcomes (legal sanctions) or content (moral rebukes offered in dicta) of judicial opinions, but also at earlier stages in the litigation process: pleading, discovery, and trial. The litigation process itself affects corporate behavior at least as much as judicial opinions do, through flushing out information and facilitating reputational sanctions.6 I then offer testable predictions on the reputational impact of litigation by outlining the factors that determine how information from the courtroom translates into reputational sanctions. One counterintuitive takeaway point is that judicial scolding does not necessarily hurt the misbehaving companies’ reputation. The reputational outcomes of litigation depend on questions such as whom the judge is scolding (is she singling out an ousted individual or criticizing an unhealthy corporate culture?), what she is scolding them for (honest incompetence or calculated disregard of market norms?), and what her scolding adds to the already existing information environment. Part III corroborates the theoretical arguments by delving into the famous Disney-Ovitz litigation7 as a case study. I analyze the content of media coverage of the Disney-Ovitz debacle before, during, and after litigation. By adopting such a methodology we gain two sets of insights that develop the reputational theory of the law. First, we learn about the relative reputational impact of each phase in litigation. For example, we learn that the verdict’s reputational impact is much more limited and favorable towards the defendant company than was previously assumed. Second, we learn about the distortions in information flows. A lot of information gets lost in transmission from the courtroom to the court of public opinion. Different information intermediaries, such as mass media or law firms, selectively choose different pieces of information to convey to their respective audiences. And defendant companies try to hijack the information flows by producing smokescreens that divert the public’s attention. Part IV sketches out the normative implications of the reputational theory of corporate law. I reevaluate the desirability of key doctrines such as Zapata.8 6. The upshot is that even cases that settle produce reputational sanctions. For empirical support for this argument, see infra note 34 and the accompanying text. 7. In re The Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005). 8. Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981). 6 STANFORD LAW & POLICY REVIEW [Vol. 26:1 I then revisit the regulatory competition debate.9 The existing literature already recognized that if Delaware wishes its law to remain the dominant state corporate law, it has to balance between appeasing the public and Washington in order to prevent federal intervention and appeasing corporate America in order to prevent corporate migration. My reputational perspective adds the angle of how exactly Delaware effectively balances this dual threat. By relying on scolding and not on direct sanctioning, Delaware courts make it harder on the public and Washington to decipher how tough the enforcement really is. Delaware courts therefore can use judicial scolding as a low-visibility favoritism tool: allowing Delaware to appear tougher on corporate America than it actually is. Part V applies the theory to a different context by examining the reputational impact of Securities and Exchange Commission (SEC) enforcement actions. Switching from litigation to regulatory investigations allows us to not only enrich the theory but also contribute to a practical and timely debate. SEC enforcement practices have recently faced mounting criticism following the Bank of America and Citigroup cases10 and have become the center of national attention. I argue here that the real problem with SEC settlements is not that the SEC leaves money on the table, but rather that the SEC leaves information on the table. Both the SEC and big firm defendants have incentives to settle quickly and for high amounts, in exchange for limiting the public release of damning information. Such information-underproduction dynamics are good for both parties but bad for society overall. I then discuss potential solutions to the problem, including evaluating the proper scope of judicial review of SEC actions.11 I conclude by briefly synthesizing the Article’s various insights, clarifying their relation to the existing literature, and outlining avenues for further research. I. HOW THE LAW SHAPES REPUTATIONAL SANCTIONS: A GENERAL FRAMEWORK To figure out how the law affects reputation, we first need to understand how reputation works. This Part fleshes out two basic points about the dynamics of reputational sanctioning, which were previously overlooked by 9. The regulatory competition literature deals with the consequences of states’ competition over corporate charters: whether state corporate law represents a race to the top or to the bottom (or not a race at all). See Mark J. Roe, Delaware’s Competition, 117 HARV. L. REV. 588, 593-96 (2003). 10. SEC v. Citigroup Global Mkts. Inc., 827 F. Supp. 2d 328 (S.D.N.Y. 2011); SEC v. Bank of Am., 653 F. Supp. 2d 507 (S.D.N.Y. 2009). 11. The issue of the proper scope of judicial review was recently explicitly addressed by the Second Circuit Court of Appeals in SEC v. Citigroup Global Mkts. Inc., 752 F.3d 285 (2014). 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 7 legal scholars.12 I first show that reputational assessments are inherently inaccurate. Legal scholars often assume that the only issue with reputational sanctioning is whether misconduct is revealed or not: once bad news breaks, the market supposedly reacts automatically. But in reality the market reaction itself is the issue. Market players often lack the information or incentives to accurately interpret revelations of misconduct. As a result, the market underreacts to some types of revealed misconduct and overreacts to others. I then show how the accuracy of reputational sanctions is dictated by the legal system. Because market players find it hard to calibrate reputational judgments on their own, they often look for information coming from the legal system as a second opinion that helps them revise their initial reaction. In other words, the market reaction to revealed misconduct is shaped by the legal system’s reaction. The law thus affects behavior indirectly by shaping reputational sanctions. I finish by providing a blueprint for applying this general reputational theory of the law to specific legal fields. A. Reputational Sanctions: How They Work and Why They Are Noisy A company’s reputation can be defined as the set of beliefs that stakeholders hold regarding the company’s quality. Stakeholders cannot directly observe the company’s abilities and intentions. As a result, stakeholders form a rough proxy: using the company’s past actions as cues, they evaluate how the company is likely to behave in the future.13 Customers make purchasing decisions based on their expectations about product quality; employees decide whether to apply for a job based on their beliefs about how top management will treat them; and so forth.14 A reputational sanction thus is simply the process of updating beliefs and lowering expectations. When news about adverse actions by a company breaks, stakeholders downgrade their beliefs about the company’s quality. The company is now perceived as more likely to defect in the future, so stakeholders’ willingness to deal with it decreases. For example, investors hearing about a corporate governance scandal will start demanding higher 12. For references to and critique of the conventional approach, see Christopher McKenna & Rowena Olegario, Corporate Reputation and Regulation in Historical Perspective, in THE OXFORD HANDBOOK 272 (Timothy G. Pollock & Michael L. Barnett eds., 2012); Juan Jose Ganuza et al., Product Liability Versus Reputation 2 (Feb. 3, 2013) (unpublished manuscript), available at http://www.webmeets.com/files/papers/earie/2013/ 371/EARIE%202013%20FGP%20JJG.pdf. 13. A company’s reputation can be thought of as the cash value of the trust that different stakeholders put in the company. Karpoff, supra note 4, at 363. I refrain from using the notion of trust here in order to avoid confusion between Bayesian belief-updating models and repeated-interaction models of reputation. See Luis Cabral, The Economics of Trust and Reputation (June 2005) (unpublished manuscript), available at http://pages.stern.nyu.edu/ ~lcabral/reputation/Reputation_June05.pdf. 14. Reputation is thus somewhat audience-specific and attribute-specific: when talking about reputation we need to ask “reputation to whom?” and “for what?” 10 STANFORD LAW & POLICY REVIEW [Vol. 26:1 corporate governance).20 Similarly, the media criticize shady accounting practices based on the visibility of companies rather than the size of the discrepancy: large, well-known companies get more negative coverage for more minor deviations.21 Taken together, the emerging pieces of evidence suggest that reputational sanctions exact heavy social costs. The costs of reputational sanctions stem not just from instances where the market does not detect corporate misbehavior. Even when market players become aware of corporate misconduct, their reaction to it is often inaccurate. Stakeholders may stop doing business with perfectly fine companies, or they may ignore early warning signs and continue doing business with rotten companies. Most importantly, the evidence suggests that the market systematically overreacts to certain misbehaviors and underreacts to others.22 Not all mistakes in reputational assessments cancel themselves out. As a result, reputational forces distort primary behavior. Companies may pick projects based on their reputational value and not on their “real” value. Reputational incentives push companies to excessively avoid some worthy behaviors (reputational overdeterrence) and excessively engage in some bad behaviors (reputational underdeterrence). So far we have explained why market players, when left alone, will have trouble producing accurate reputation information. But in reality the market is rarely left alone. Adverse actions are interpreted and assessed not just by market arbiters, but also by legal arbiters. The legal system produces as a by- product an informational public good: a version of what and how things happened in given cases.23 The next Subpart maps the different ways in which the information coming out of the legal system affects reputational sanctions. B. How Litigation Affects Reputation Many Law and Social Norms analyses assume away complementarities between law and reputation, instead treating the two systems as independent of each other.24 In this Subpart, I challenge the conventional view by fleshing out 20. See John E. Core et al., The Power of the Pen and Executive Compensation, 88 J. FIN. ECON. 1, 17 (2008). 21. See Gregory S. Miller, The Press as a Watchdog for Accounting Fraud, 44 J. ACCNT. RES. 1001 (2006). 22. For an elaboration see Shapira, supra note 17, at Subpart I.C (providing, also, examples of biases that lead to over/underdeterrence, such as the state of the overall economy—the market underreacts when the economy is booming and overreacts when the economy is down; the saliency of the issue in question; and the type of harm done—the market underreacts to multiple small harms and concealed harms, and overreacts to harms to easily identifiable victims). 23. See Érica Gorga & Michael Halberstam, Litigation Discovery and Corporate Governance: The Missing Story About the “Genius of American Corporate Law,” 63 EMORY L.J. 1427-28 (2014). 24. For the conventional approach, see supra note 12. To illustrate, consider Polinsky and Shavell’s proposal to abolish product liability for widely sold products. The logic of 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 11 two channels through which the law influences reputational sanctions: “first- opinion effects,” which occur before the market reacts to misconduct, and “second-opinion effects,” which occur after the market’s initial reaction. 1. First-Opinion Effects The first type of effect that the law generates is that of setting a reputational sanction in motion. The most intuitive and studied example comes from disclosure requirements, which incentivize corporate decision-makers to publicly reveal information relating to corporate misconduct. Whistleblower laws also mitigate the asymmetric information about corporate failures, by incentivizing employees to reveal information about their companies’ misconduct. Aside from legislation and regulations, litigation—our focus in this Article—can draw market players’ attention to previously unnoticed corporate misbehavior. Sometimes a company breaches its explicit or implicit contractual obligations toward a certain stakeholder, but the harmed party finds it too costly to communicate the violation to third parties. The legal system gives the harmed party a right to sue the company for damages, thus indirectly setting the wheels of reputational sanctions in motion. The mere filing of a lawsuit (not to mention information revealed during litigation) may attract the attention of other stakeholders and propel them to downgrade their beliefs about the company.25 In all these cases, the law has a “revealing misconduct” effect on the market. When the legal system facilitates the injection of new information into the market, it reduces the detection costs of reputation control systems, thus increasing the chances that misbehavior will be punished by the market. Another channel through which the law sets reputational sanctions in motion is reduction of the enforcement costs of reputation control systems: the costs of acting against detected misbehavior.26 After all, not all revealed misconduct is automatically punished by the market. Sometimes market players know the facts (i.e., learn about a certain suspect behavior) but are unclear about what norms are pertinent to the facts. The legal system helps by such a proposal is that if nonlegal forces are strong enough to carry most of the burden of deterrence, then it is not cost-effective to keep a costly adjudication system simply for the sake of an incremental contribution to deterrence. A. Mitchell Polinsky & Steven Shavell, The Uneasy Case for Product Liability, 123 HARV. L. REV. 1437 (2010). At the heart of such an argument lies an implicit assumption that the legal system and the nonlegal system are independent of each other. Polinsky and Shavell assume that we can remove the law— remove the background threat of litigation—and the market forces will continue to function just the same. 25. Cf. G. Richard Shell, Opportunism and Trust in the Negotiation of Commercial Contracts: Toward a New Cause of Action, 44 VAND. L. REV. 221, 271 n.223 (1991) (noting the common practice to search for past and pending legal disputes of potential business counterparties). 26. The terminology follows Robert Clark’s typology in Laws, Markets, and Morals (Jan. 2010) (unpublished manuscript) (on file with author). 12 STANFORD LAW & POLICY REVIEW [Vol. 26:1 clarifying—either in legislation or through judicial opinions—the proper standards of market behavior. By demarcating clear norms, judges and legislatures make it easy for market players to realize whether the line was crossed in a given case. Such a “clarifying standards” notion has much in common with rational choice theories of expressive law.27 In both instances—revealing misconduct and clarifying standards— litigation can push market players to react to corporate misconduct. But there are many situations where market players do not need any pushing. Misconduct by large public companies is often revealed (and acted upon) long before a legal complaint is even filed. Indeed, a recent comprehensive empirical study found that the filing of a lawsuit was responsible for breaking news about financial misconduct in only 6.4% of revealed violations.28 Market players often learn about misbehavior from other sources, such as investigative reporters, whistleblowers, or financial reporting. Still, even when the legal system’s reaction is lagged, it may nevertheless affect the market, albeit in a different way, to which we turn next. 2. Second-Opinion Effects The same bad news that triggered market reaction may eventually propel plaintiffs’ lawyers to file a lawsuit or a regulator to initiate investigations. In the process of determining whether to impose legal sanctions, the legal system often produces information on questions such as what top managers knew and when they knew it. The information produced during litigation or investigations thus creates another “third-party assessment” of the company’s behavior, and because such information is often publicly available, it allows market players to reevaluate their initial assessment of the company. In that aspect, the legal system’s lagged version generates second-opinion effects in reputation markets. In the second-opinion analogy, stakeholders face a decision on how to update beliefs about a misbehaving company: market arbiters (media, watchdogs, or analysts) are the first-opinion givers, and legal arbiters are the second-opinion givers. The legal system’s version often makes a high-quality second opinion because it is more accurate and nuanced than the market’s initial reaction. The value of the legal system’s second opinion can stem from the opinion-givers themselves: judges are often perceived as more expert and/or disinterested than are typical market arbiters (such as columnists or watchdogs). More importantly, the legal system vests powers in its players (judges, investigators, or private litigants) to probe and demand inside 27. See, e.g., Melvin A. Eisenberg, Corporate Law and Social Norms, 99 COLUM. L. REV. 1253, 1269-71 (1999); Richard H. McAdams, An Attitudinal Theory of Expressive Law, 79 OR. L. REV. 339 (2000). 28. Jonathan M. Karpoff et al., Database Challenges in Financial Misconduct Research 15 (May 30, 2014) (unpublished manuscript), available at http://ssrn.com/abstract=2112569. The filing of a lawsuit lags the date in which the market first learned about misconduct by a median of twenty-three and an average of 150 days. Id. at 16. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 15 and resources to mine legal proceedings for second opinions. In other words, players in the market for publicly-traded companies are more interested in the empirical truth and de-biasing of information than are consumers of news in other contexts.33 Indeed, recent empirical studies show that sophisticated investors continuously monitor and react to information disseminated during litigation.34 On the supply side, the main adjudicators of corporate behavior—Delaware courts—are well positioned to provide timely, comprehensible, and thorough reputation information, for several reasons. First, Delaware courts are well respected in the legal and business communities.35 The nonpolitical appointment process (Delaware judges frequently come from the bar) and the specialized docket allow judges to develop expertise and a broad perspective on market norms. Second, the specialized and small docket enables Delaware judges to adjudicate disputes relatively quickly, producing information in a timely manner.36 Finally, the legal doctrines in Delaware corporate law—both procedural and substantive—are geared towards providing reputation-relevant information.37 The upshot is that corporate litigation is likely to have a meaningful effect on the reputation of businesspeople and companies. The next question, then, is: How, or in what direction? Does litigation necessarily increase the reputational sanction attached to misconduct? Does it affect the reputations of individual managers differently than it affects organizations? The next Part explores these issues in depth, in the context of fiduciary duty litigation. II. CORPORATE LITIGATION’S IMPACT ON NONLEGAL SANCTIONS How does corporate law work? This question has puzzled corporate legal scholarship for decades. The puzzle stems from the apparent lack of legal 33. See Jeremiah Green et al., Business Press Coverage and the Market Pricing of Good and Bad News 3-4 (Jan. 2014) (unpublished manuscript), available at http://ssrn.com/ abstract=1780162. 34. See Vladimir Atanasov et al., Does Reputation Limit Opportunistic Behavior in the VC Industry? Evidence from Litigation Against VCs, 67 J. FIN. 2215, 2218 (2012) (arguing that venture capitalists’ reputation is affected by information produced in early stages of litigation); Lars H. Haβ & Maximilian A. Müller, Capital Market Consequences of Corporate Fraud (2011) (unpublished manuscript), available at http://www.eea- esem.com/files/papers/eea-esem/2012/988/paper.pdf (arguing that the same reputational effect applies outside the VC context). In an interview conducted with a representative of Courtroom Connect—a company that streams online webcasts of Delaware trials—I learned that an important clientele of streaming services is institutional investors who monitor legal disputes in real time and alter investment decisions accordingly. See Courtroom Connect, supra note 5. 35. See Geoffrey P. Miller, A Modest Proposal for Fixing Delaware’s Broken Duty of Care, 2010 COLUM. BUS. L. REV. 319, 330-31 (2010); Rock, supra note 2, at 1102. 36. See, e.g., Jill E. Fisch, The Peculiar Role of the Delaware Courts in the Competition for Corporate Charters, 68 U. CIN. L. REV. 1061, 1086 (2000). 37. I elaborate on this point infra Part IV.A. 16 STANFORD LAW & POLICY REVIEW [Vol. 26:1 sanctions. Corporate decision-makers practically never pay out of pocket for their misbehavior,38 so presumably the law lacks teeth. An influential strand of the literature suggested that corporate law’s teeth consist in facilitating nonlegal sanctions. But so far the existing accounts have failed to develop a satisfactory theory of how nonlegal forces work or how exactly the law facilitates them. I start this Part by identifying the gaps in the existing approach. Current accounts focus on how judicial comments induce guilty feelings among misbehaving directors or on social shaming among misbehaving directors’ peers.39 In other words, the current approach deals narrowly with how verdicts ramp up the moral sanctions for misbehaving. In reality, though, verdicts are rare, and the moral rebukes offered in them seldom reach their presumed audiences. It therefore makes sense to shift our focus to how the litigation process as a whole (not just verdicts) shapes the reputational (not just moral) sanctions for misbehaving. I outline three important factors that determine how information from the courtroom translates into the court of public opinion. The main takeaway point is that, counterintuitively, not every case of judicial scolding hurts the company’s reputation. To predict the reputational impact, we need to ask who the judge is scolding (an ousted individual or an unhealthy corporate culture?); what she is scolding for (honest incompetence or calculated disregard for shareholder interests?); and what her scolding adds to the preexisting information environment. A. Litigation’s Impact on Moral Sanctions: “Saints and Sinners” Revisited Delaware fiduciary duty litigation features a striking pattern: no sanctioning but lots of talking. Delaware judges usually refrain from imposing legal sanctions on company decision-makers, but they do not shy away from criticizing the directors’ behavior whenever they see fit.40 This fact pattern of lengthy, fact-intensive, judgmental verdicts raises a puzzle: what is the point in preaching if you are not going to sanction? If Delaware courts are not enforcing fiduciary duties, why do they bother talking about them so much? Several prominent corporate legal scholars suggest a solution to this puzzle: preaching is the point, they claim. Preaching is not an afterthought but rather the main function of Delaware decisional law. It is through richly detailed narratives of good and bad corporate behavior that Delaware judges 38. Supra note 1. The main justifications for refraining from sanctioning are discouragement of productive risk-taking in businesses, judicial incompetence, and the ability of shareholders to fend for themselves by diversifying risks. 39. See Rock, supra note 2. 40. For empirical support for the argument that Delaware courts rely heavily on moralism, see John C. Coates, Managing Disputes Through Contract: Evidence from M&A 35 n.54 (Aug. 14, 2011) (unpublished manuscript), available at http://papers.ssrn.com/ sol3/papers.cfm?abstract_id=1975423. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 17 control corporate behavior.41 Once the morality tales of corporate saints and sinners become publicly available, they unleash all sorts of nonlegal forces. In one version of this “saints and sinners” approach to corporate law, directors hate being dressed down in verdicts because it reduces the esteem that they get from colleagues and peers (“external moral sanctions”).42 In another version, directors who are subject to judicial scolding suffer not from disesteem of others but rather from their own sense of guilt (“internal moral sanctions”).43 And because judges elicit the opprobrium of third parties and/or guilt feelings of first parties simply by what they say, they get to sanction and deter misbehavior without imposing legal sanctions. The saints and sinners theory of corporate law does a great job of spotlighting one indirect deterrence element of corporate law. It correctly directs our attention to the possibility that corporate litigation shapes behavior not just through the outcomes but also through the content of judicial opinions. But as the following paragraphs explain, the existing approach has too narrow a focus. I propose here a shift in perspective: from focusing just on how judicial comments affect moral judgments44 to focusing on how the litigation process as a whole affects reputational judgments. First, focusing just on judicial opinions is problematic because most legal disputes settle. Judges get very few chances to offer moral rebukes in verdicts.45 Cases that settle do not produce moralistic impact, but they may nevertheless affect the market reaction: not by shaping moral beliefs but rather by shaping factual beliefs. The process itself prior to settlements (pleading, discovery, and trial) sheds light on reputation-relevant information. Indeed, recent empirical studies show that market players monitor and react to events during the early stages of the process.46 Second, focusing just on moralistic impact is problematic because the typical verdict sends mixed messages: by legally exonerating defendants, the verdict dilutes the power of any moralistic condemnations made in dicta. The 41. The two most representative accounts are Rock, supra note 2, and Blair & Stout, supra note 1. While there are various other accounts of corporate law and social norms that vary in nuances, they all share enough similarities to be grouped for our purposes under the “saints and sinners” umbrella term. 42. See Rock, supra note 2. 43. See Blair & Stout, supra note 1. 44. For acknowledgments that existing accounts focus on moralistic and not reputational consequences, see, for example, Rock, supra note 2, at 1013 (focusing on disesteem); David A. Skeel, Jr., Shaming in Corporate Law, 149 U. PA. L. REV. 1811, 1814, 1856 (2001) (focusing on moral disapproval). The few analyses that touch the reputational outcomes of litigation do not develop it into a full theory. See, e.g., Gordon, supra note 32, at 1489. 45. See Miller, supra note 35, at 329. 46. Supra note 34; see also JOHN D. LYTTON, HOLDING BISHOPS ACCOUNTABLE 205 (2008); Gorga & Halberstam, supra note 23 (noting that the corporate law literature fails to recognize the importance of discovery in shaping corporate behavior). 20 STANFORD LAW & POLICY REVIEW [Vol. 26:1 holds office, or what other top managers knew about her actions.53 Granted, in many cases the intuitive answer applies: dressing down an individual manager does reflect badly on the company. But there also are common scenarios where, counterintuitively, dressing down specific managers may actually boost the company’s reputation (or at least not hurt it). Consider two examples. First, the judge often dresses down a manager who is already gone or on her way out of the company. Such judicial finger-wagging would probably damage the ousted manager’s labor-market reputation, but it could help repair the company’s reputation. This is because singling out one individual as a sinner gives rise to a “scapegoating” dynamic. As the crisis management literature shows, one of the most effective recovery strategies for companies is decoupling: acknowledging the problem while isolating and localizing it.54 And scapegoating is an especially effective form of decoupling. By attributing the problem to a rogue element that was subsequently purged, the company distances itself from the wrongdoing. Accordingly, when a judge singles out the ousted manager for opprobrium, she lends credibility to the decoupling claims and directs the public’s attention away from more systematic problems. In another typical scenario, the judge scolds a manager for making mistakes out of incompetence. Here again, the individual’s labor-market reputation will probably take a hit (who wants to hire an incompetent manager?). But the impact on the company’s reputation is not necessarily negative and could even be positive. Crisis management experts maintain that companies in crises stand better chances of repairing their reputation when individual managers are portrayed as less than perfect.55 If stakeholders perceive the leader as perfect and in total control, they assume that she could have prevented the adverse outcome. As a result, stakeholders will interpret the company’s misconduct as intentional and indicative of future behavior (that is, arising from deep-rooted disregard for shareholder interests and market norms in general). By contrast, if stakeholders perceive the leader as less than perfect, they are more likely to interpret the adverse outcomes as a result of more easily fixable mistakes.56 53. See, e.g., ERIC DEZENHALL & JOHN WEBER, DAMAGE CONTROL 141 (2007); E. Deanne Brocato et al., When Things Go Wrong: Account Strategy Following a Corporate Crisis Event, 15 CORP. REPUTATION REV. 35, 36 (2012) (“Both theoretical and empirical research on corporate crises suggest that individuals and corporations may be viewed differently when evaluated, following a corporate crisis event.”). 54. See, e.g., Anna Lamin & Srilata Zaheer, Wall Street vs. Main Street: Firm Strategies for Defending Legitimacy and Their Impact on Different Stakeholders, 23 ORG. SCI. 47, 50-54 (2012). 55. See DEZENHALL & WEBER, supra note 53. 56. To be sure, in the business world it is sometimes better to be (perceived as) immoral than incompetent. Still, there are areas where incompetence is considered less deep- seated and easier to root out than lack of integrity. Cf. KIMBERLY D. ELSBACH, ORGANIZATIONAL PERCEPTION MANAGEMENT 60 (2006); John Hendry, The Principal’s Other Problems: Honest Incompetence and the Specification of Objectives, 27 ACAD. MGMT. REV. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 21 2. Scolding Compared to What? What Information Is Available vs. How It Is Diffused Misconduct by large publicly-traded firms is usually tried in the court of public opinion before it is tried in courts.57 As a result, the judge’s verdict is often a lagged second opinion. Stakeholders with enough stake and sophistication to mine verdicts for information do not read verdicts in isolation. Rather, they compare the judge’s version to existing versions produced by market arbiters. Any analysis of litigation’s reputational impact thus should ask what relative addition or subtraction of reputational sanctions has been produced by the verdict. Such an analysis requires understanding the baseline: the pre-verdict information environment. It is useful to break down the pre-verdict information environment into two stages: before and after the lawsuit is filed. When bad news breaks, market players react to it almost immediately, while the legal system often takes some time to get involved. And the trivial yet overlooked point is that a lot of information is produced before the legal system gets involved. When the company or issue at hand is salient and attractive enough, private info- intermediaries have incentives to quickly find out the facts about what happened58 and offer interpretations about how it happened.59 Then, after a complaint is filed, more information is produced in the early stages of litigation (post-filing but pre-verdict). Information produced during pleading, discovery, and trial shapes reputational sanctions through two channels: facts and framing. The process gives market players more raw facts and inside information to work with, such as internal e-mail communications or board minutes that provide details about what top managers did (or did not do) to prevent the failure. The litigation process also produces readily available packaging of the facts. Plaintiffs, defendants, and third-party intermediaries often use tidbits from different stages (complaint, motion to dismiss, expert testimonies) to help their specific interpretations gain traction in the court of public opinion.60 Between the information produced by private info-intermediaries and information produced during the litigation process, not much new information (if any) is produced in judicial opinions. Verdicts contain mostly stale information. To be sure, verdicts still matter in the court of public opinion. But 98 (2002) (identifying contexts where shareholders can more easily replace an incompetent element than root out moral hazard). 57. See supra note 26. 58. A typical example comes from interviewing former insiders who deliver juicy details on how things went wrong. See generally Alexander Dyck et al., Who Blows the Whistle on Corporate Fraud, 65 J. FIN. 2213 (2010). 59. A typical example comes from critical editorials that couch the story under some catchable category such as a story about corporate greed or power-tripping CEOs. See generally DEZENHALL & WEBER, supra note 53, at 15, 39. 60. Cf. Lytton, supra note 46, at 201 (discussing the framing role of litigation processes in general). 22 STANFORD LAW & POLICY REVIEW [Vol. 26:1 they matter in different and hitherto understudied ways. The main impact of verdicts is not in introducing new information but rather in affecting how existing information is diffused. The last point deserves elaboration. Corporate legal scholars usually ignore issues arising from diffusion of information. We assume that market players either have or do not have information, or that once information is revealed, it will be fully reflected in stock prices.61 But in reality the way that information is diffused matters. Information intermediaries matter. For example, a burgeoning empirical literature shows that the scope and tone of media coverage affects market reactions to stale information.62 A classic illustration comes from a study finding that a front-page New York Times article about a biotech company caused the stock prices to skyrocket, even though the article contained no new information and actually repeated information that the Times previously had published in a back-page story.63 Accordingly, to the extent that judicial opinions (or more generally litigation) affect the scope and tone of media coverage, they impact reputational assessments even without producing new information. Much like earlier stages in the process, judicial opinions often affect the saliency and credibility of existing information. Judicial opinions add saliency by recalling the attention of the media to a certain issue, providing media reporters with readymade quotes, and reducing journalists’ risk of defamation liability.64 Opinions also add credibility by certifying existing information.65 After all, not all sources of information are created equal:66 stakeholders are more likely to update their 61. Cf. Alexander Dyck & Luigi Zingales, The Corporate Governance Role of the Media, in THE RIGHT TO TELL 108-09 (2002). 62. See Brian J. Bushee et al., The Role of the Business Press as an Information Intermediary, 48 J. ACCT. RES. 1 (2010) (finding that coverage by mass media affects stock returns even when not breaking new information); Lily Fang & Joel Peress, Media Coverage and the Cross-section of Stock Returns, 64 J. FIN. 2023 (2009) (same). The scope of media coverage affects the market by drawing the attention of more investors to information that was previously known only to a small group of sophisticated investors. See, e.g., Paul C. Tetlock, All the News That’s Fit to Reprint: Do Investors React to Stale Information?, 24 REV. FIN. STUD. 1481 (2011); Paul Ma, Information or Spin? Evidence from Language Differences Between 8-Ks and Press Releases (Nov. 29, 2012) (unpublished manuscript), available at https://server1.tepper.cmu.edu/seminars/docs/Ma%20Job%20Market%20Paper. pdf. 63. See Gur Huberman & Tomer Regev, Contagious Speculation and a Cure for Cancer: A Nonevent that Made Stock Prices Soar, 56 J. FIN. 387 (2001). 64. See Tamar Frankel, Court of Law and Court of Public Opinion: Symbiotic Regulation of the Corporate Management Duty of Care, 3 N.Y.U. J.L. & BUS. 353, 357 (2007); Lytton, supra note 46, at 95. 65. See Shapira, supra note 17, at Subpart II.B.2 (describing how the Salomon Brothers and Arthur Anderson crises illustrate how litigation/investigations can lend credibility or discard the company’s version). 66. For studies showing that stakeholders react differently to identical pieces of information coming from different sources, see DellaVigna & Gentzkow, supra note 18, at 657; Cass Sunstein, Breaking up the Echo, N.Y. TIMES (Sept. 17, 2012), http://www.nytimes.com/2012/09/18/opinion/balanced-news-reports-may-only-inflame.html 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 25 intensive decision that was filled with caustic criticism but ultimately exonerated the defendants who walked away winning. Many corporate legal scholars have since hailed the Disney decision as a paradigmatic example of the saints and sinners approach: as illustrating how Delaware courts avoid legal sanctions while ramping up nonlegal sanctions, as exonerating while condemning.76 And this is exactly what makes Disney such an interesting case study for our purposes; a deeper look reveals that even this seemingly clear-cut example does not follow the saints and sinners theory’s predictions.77 Instead, it corroborates the alternative theory presented here.78 The Disney saga illustrates the reputational dynamics of big-case litigation: the verdict does not add new information because almost every fact cited by the Chancellor had already been covered by the media. Disney also illustrates how a seemingly caustic verdict when read in isolation is actually favorable to the company when considering our three key factors: the preexisting information, who the judge is scolding, and what he is scolding them for. What distinguishes my reading of Disney from the numerous previous dissections of the case is the focus on relative nonlegal impact. Many scholars have focused on doctrinal analysis but ignored the decision’s nonlegal impact. The scholars who have touched on the nonlegal impact simply note the decision’s moralistic tone and assume that it ramps up the nonlegal sanctions and deterrence. I adopt a different methodology that shifts our focus to the dynamics of reputational sanctions. Using a content analysis of the media coverage of the Ovitz debacle, I explore how the reputational capital of Disney 76. See, e.g., Frankel, supra note 64, at 363-64; Johnson, supra note 49, at 863 (“[T]he opinion was a paragon of how Rock had earlier described Delaware opinion. It was detailed, normatively saturated, judgmental, and laced with scolding, sometimes acerbic, moral reproof.”); Miller, supra note 35, at 326; David M. Wilson, Climate Change: The Real Threat to Delaware Corporate Law, Why Delaware Must Keep a Watchful Eye on the Con- tent of Political Change in the Air, 5 ENTREPRENEURIAL BUS. L.J. 481, 488 (2010). 77. To use the qualitative methodology jargon, I employ the Disney case-study here in a “constructivist” mode of research: to illustrate, shed light, and serve as a check on competing theoretical frameworks. Accordingly, I select the Disney case (and other cases throughout the Article) not randomly but rather “purposively.” The Disney litigation serves as a “crucial, ‘most likely’ case:” since it is widely considered the paradigmatic example for an existing approach (saints and sinners), digging deep into it illustrates the problems in the hegemonic theory and opens up space for my alternative framework. See THE SAGE ENCYCLOPEDIA OF QUALITATIVE RES. 69-70 (Lisa M. Given ed., 2008). 78. To clarify: I do not claim that the Disney case study and my qualitative empirical work more generally produce conclusive proofs of my theory or generate external validity in the sense used in quantitative studies. What my independent work (interviews, case studies, content analysis) produces, I hope, is a rich theory, one that is valid in the modest sense of prima facie credibility. The Disney case study, for example, indicates the plausibility of the theory’s testable predictions. Moreover, by building on the work done through case-studies and interviews, we can better identify issues and pave the way for subsequent quantitative probes. To go back to the qualitative methodology jargon, this method is called “exploratory sequential mixed methods design”: the researcher approaches a new terrain with more qualitative methods, and then once he identifies initial patterns, he can look to corroborate them with a later quantitative stage. Id. at 527. 26 STANFORD LAW & POLICY REVIEW [Vol. 26:1 and its top managers fluctuated before, during, and after litigation. The media coverage analysis, supplemented with insights from my interviews with key players,79 allows us to decipher the relative reputational impact of litigation.80 In other words, by examining how the court of public opinion treated the Ovitz affair before the verdict, we can tease out the real difference that the verdict made as a second opinion. A. Information Produced Before Litigation Started The Disney lawsuit was filed in 1997. But by that time the court of public opinion had already been in session for a year. And the company was losing, badly. The media covered the Disney-Ovitz debacle extensively during 1996. Investigative journalists were the first to uncover the problems with Disney’s management. One lead story followed another, and by the second half of 1996, each medium was competing to come up with vivid details about the bad blood between Disney’s top managers.81 The early reports highlighted how Disney’s number one (Michael Eisner) ran his own show without checks and balances from the board82 while Disney’s new number two (Ovitz) was in over his head.83 At the time the company was denying the stories in an attempt to limit their negative reputational impact. But the denials rang hollow when investigative reporters exposed internal documents (such as Eisner’s internal memos tarnishing Ovitz) and quotes from former insiders going on record about Disney’s governance flaws.84 Then in late 1996 the company could no longer deny the problems. Ovitz was fired, and the company had to file press releases and submit information to 79. I especially benefited from phone interviews with reporters who covered the Disney-Ovitz debacle throughout the years: Corie Brown, who covered the litigation for Newsweek (Jan. 20, 2014); Kim Christensen, who covered post-verdict developments for the Los Angeles Times (Jan. 17, 2014); Kim Masters, who wrote multiple articles and a book- length account of Disney’s debacles (June 14, 2013); and Richard Verrier, who covered the litigation for the Los Angeles Times (Jan. 23, 2014). 80. See Gerald Ferris et al., Personal Reputation in Organizations, in ORGANIZATIONAL BEHAV. 222 (2d ed. 2003) (arguing that although media coverage can be used as a proxy to decipher the historical record of reputation, the media does not only record but also affects reputation). 81. See Ken Auletta, Marriage, No Honeymoon, NEW YORKER, July 29, 1996; Kate Bohner, Michael Versus Michael, FORBES, July 1, 1996, at 20; Corie Brown, Clash of the Titans?, NEWSWEEK, July 10, 1996. 82. See, e.g., T. L. Stanley, Definite Difference at Disney, MEDIAWEEK, Apr. 22, 1996. 83. See, e.g., Ronald Grover & Elizabeth Lesly, The Humbling of Mike Ovitz, BUS. WEEK (May 27, 1996), http://www.businessweek.com/stories/1996-05-26/the-humbling-of- mike-ovitz; Bernard Weinraub & Geraldine Fabrikant, A Mouseketeer with an Attitude: Ovitz’s Past Haunts Disney’s Future, N.Y. TIMES, June 10, 1996, at D1. 84. A Vanity Fair story, for example, was based on interviews with dozens of former and current Disney insiders. Bryan Burrough & Kim Masters, The Mouse Trap, VANITY FAIR (Dec. 1996), http://www.vanityfair.com/society/features/1996/12/ovitz-199612. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 27 the SEC. The injection of new information intensified the market reaction. It was then—via the company’s own reporting—that the public learned about the hefty severance package awarded to Ovitz after an unsatisfactory year at the helm. Now market and social arbiters were competing over who would offer stronger condemnations of Disney. Large institutional investors claimed to be enraged.85 The president of the National Association of Corporate Directors said that Disney’s board was “living in the dark ages” and was too beholden to Eisner.86 And practically all the major newspapers ran editorials that attributed the Ovitz debacle to a corporate culture of total disregard for shareholder interests and societal norms.87 Overall, the media coverage of the Ovitz debacle was extensive in scope and unfavorable in tone from the get-go. Any stakeholder of Disney had the chance to learn about the problems and downgrade her beliefs about the company’s management integrity, before a lawsuit was even filed. Corporate legal scholars treat the 2005 verdict as setting a reputational sanction in motion.88 But in reality the reputational system was already in motion in 1996. Those involved in the Ovitz debacle suffered a huge initial reputational hit. Before litigation began, the company was already depicted as the poster child for bad corporate governance, and its top managers were ridiculed.89 In fact, it was the reputational system that set the legal system in motion: the lawyers based their 1997 complaint on facts and interpretations taken straight from the media coverage.90 85. See, e.g., Bruce Orwall, Disney Holders Decry Payouts at Meeting,WALL ST. J., Feb. 26, 1997, at A3; Bruce Orwall & Joann Lublin, The Rich Rewards of a Hollywood Exit, WALL ST. J., Dec. 16, 1996, at B1. 86. See KIM MASTERS, THE KEYS TO THE KINGDOM 380 (2000). 87. See, e.g., id. at 376-77; Holman W. Jenkins, Beavis and Butthead Do the Disney Shareholders, WALL ST. J., Jan. 7, 1997, at A17 (remarking that, “[N]obody in the real world . . . gets that kind of money for flubbing up after a year on the job,” as if the headline was not enough); A.M. Rosenthal, Hardtack for the Journey, N.Y. TIMES, Dec. 17, 1996, at A25. 88. Frankel, for example, claims that “[b]y telling the whole world what was happening within Disney the decision allows us to become somewhat of a peeping tom,” and that the decision “carves out a process by which the media becomes aware of an issue.” Frankel, supra note 64, at 365, 367. 89. See, e.g., IESE BUS. SCH. CASE STUDY, MICHAEL EISNER AT DISNEY (2005) (noting in retrospect that Eisner went from being considered a business guru to a regular on Forbes’ annual list of World’s Worst CEOs, facing a shareholder revolt, and being forced to resign as chairman); ROBERT SLATER, OVITZ 301 (1997) (same); Nikky Finke, Poof! Mike Ovitz, from Sorcerer to Schmo, N.Y. OBSERVER, Sept. 23, 1996 (describing Ovitz as powerless and Eisner’s whipping boy); The One Time Lion-King, ECONOMIST (Sept. 16, 2004), http://www.economist.com/node/3196003 (noting in retrospect that under Eisner, “Disney became a byword for poor corporate governance”). 90. See John Gibeaut, Stock Responses, 89 ABA J. 38, 38 (2003) (noting that the initial lawsuit relied heavily on “conclusory statements from newspaper editorials about Ovitz’s highly publicized exit”). 30 STANFORD LAW & POLICY REVIEW [Vol. 26:1 Recognizing the important informational role of the process also pushes us to rethink the role of verdicts. Judges base their interpretations on information gleaned from discovery, testimonies, and experts’ reports. In cases with big firm defendants, such as Disney, the same information that the judge relies upon often gets diffused immediately. By the time the judge releases her version, the public is already aware of the information contained in it. Verdicts in big cases thus fulfill a different informational role than previously assumed: they affect reputational sanctions not by providing new information but rather by constructing and disseminating existing information. The next Subpart looks at the Disney opinion through such a prism. 2. The Real Impact of the Verdict Now that we understand how the court of public opinion treated the Ovitz affair prior to the verdict, we can turn to analyze what difference the verdict really made. Rereading the decision along with the media coverage of it generates one immediate conclusion: the conventional view that sees the verdict as a reputational deathblow to everyone involved is misguided. Granted, Chancellor Chandler’s version contains some quotable caustic comments. But it also provides more nuanced and contextual explanations for the Ovitz debacle. Unlike the prevalent preexisting interpretations of what went wrong in Disney, the verdict attributes the bad outcome to rare external conditions rather than to deep-rooted disregard for market norms. And the Chancellor reserves his strongest criticisms for individuals who were already ousted from Disney, thus implicitly creating a separation between bad (ousted) individuals and a good company. As a result, to the extent that the verdict changed stakeholders’ beliefs, it probably pushed stakeholders into thinking more positively about the company and its incumbent management. a. Emphasizing the Context The Chancellor opens his version with an explanation of the hiring: why Disney’s board rushed to hire someone with no experience in running a large public company, and then on top of that, signed an outrageous severance package provision. Here the verdict’s version differs from preexisting versions by putting more emphasis on the context. The Chancellor highlights from the outset (and then reiterates constantly)99 the “perfect storm” that pushed Disney into the Ovitz affair: Disney’s previous president died in a helicopter crash; Disney’s CEO (Eisner) suffered from a heart condition; and the company was in the midst of major expansions. Due to these unusual circumstances, the company desperately needed a new president to take the burden off the ailing Eisner in the immediate term and to provide an insurance and succession plan 99. See In re The Walt Disney Co. Derivative Litig., 907 A.2d 693, 699, 702, 762, 770, 771, 778 (Del. Ch. 2005). 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 31 for the long run. Targeting Ovitz as the quick-fix made sense at the time, since he was considered Hollywood’s number one power broker.100 And promising Ovitz a hefty severance package was necessary in order to lure him from his previous lucrative position and away from Disney’s competitors who were courting him.101 By making the context more salient,102 the verdict helps stakeholders overcome biases that plague their reputational assessments. Most notably, the Chancellor opens his decision by explicitly warning the readers from hindsight bias: do not ask yourself whether the board’s decisions make sense to you now, he tells the reader; ask whether they made sense at the time they were taken.103 The Chancellor then provides the readers with tools to mitigate their hindsight bias: he extends the timeframe by spotlighting the events that preceded Ovitz’s hiring and reminds the reader not to evaluate Disney’s management integrity according to twenty-first century best practices (which were not relevant when the Ovitz affair occurred).104 Most notably, the Chancellor emphasizes that Disney’s stock prices jumped through the roof when Ovitz’s hiring was announced.105 Amazingly enough, this important fact was largely missing from the preexisting accounts of the Ovitz affair in the media. Emphasizing the context also mitigates the readers’ tendency to adopt causal explanations. Remember that the pre-verdict narratives were predominantly causal: if Disney hired an incompetent president only to cushion his way out after a year with $140 million of shareholders’ money, then Disney’s decision-makers must lack any regard for shareholders’ interests, right?106 Wrong, says the Chancellor. No one in Disney set out to hurt 100. Id. at 701-02, 764-65. 101. Id. at 702. The verdict changed the media coverage’s tone dramatically. Prior to the verdict editorials explained Ovitz’s severance package as a blatant disregard of market norms. Following the verdict editorials explained the package as a reasonable business decision. See, e.g., The Happiest Board on Earth, L.A. TIMES, Aug. 11, 2005, at B12 (“That kind of ‘downside protection’ was central to getting Ovitz to leave CAA for Disney, and it’s endemic to the Hollywood way of doing business.”). 102. To emphasize: the facts that the Chancellor cites were not new. But by packaging the facts with a seal of approval from a Delaware judge, the Chancellor increased the likelihood that stakeholders would reevaluate their initial assessment. Indeed, the media coverage that never mentioned the “perfect storm” that explains Ovitz’s hiring prior to the verdict began emphasizing it after the verdict. See, e.g., Laura Holson, Ruling Upholds Disney’s Payment in Firing of Ovitz, N.Y. TIMES, Aug. 10, 2005, at A1. 103. See Disney, 907 A.2d at 698. The media echoed the call to beware of hindsight: Holson, supra note 102; Kathy M. Kristoff, Ovitz Ruling Is a Limited Win for Directors, L.A. TIMES, Aug. 10, 2005, at C1; Regulating Fantasyland, Aug. 12, 2005, N.Y. TIMES, at A18. 104. See Disney, 907 A.2d at 697. 105. Id. at 708 (noting how Disney’s market capitalization increased by more than $1 billion upon announcement). 106. See supra note 84. 32 STANFORD LAW & POLICY REVIEW [Vol. 26:1 shareholders.107 In fact, Disney decision-makers—along with the rest of the world, as the stock price reaction indicates—thought that they were creating shareholder value by hiring Ovitz.108 b. Scolding for Honest and Transient Mistakes After explaining the hiring, the Chancellor turns to explaining the firing. How come Ovitz performed miserably at Disney? Why was he not fired earlier? Most importantly, why was he not fired “for cause,” which could have saved the need to pay his severance package? Here, the Chancellor’s answers focus on “mismatch of cultures.” Ovitz and the incumbent managers wanted the experiment to work, the Chancellor tells us, but Ovitz simply experienced difficulties assimilating to Disney. Ovitz was flashy, conspicuous, and tried to “agent” his colleagues while the corporate culture was more blue collar and no- nonsense.109 Corporate legal scholars viewed the Chancellor’s vivid descriptions of the mismatch as humiliating the defendants.110 But such a view misses two important aspects of reputational sanctions: it ignores the baseline (how does the Chancellor’s version compare to preexisting ones?) and the distinction between individual- and organizational-level reputations. Attributing the failure to unanticipated mismatches and misperceptions is relatively favorable to the company’s reputation. Remember that most preexisting versions talked about how Ovitz’s failure was well anticipated: Disney’s incumbent management hired an obviously incompetent guy and then intentionally tripped that guy.111 Moreover, according to the preexisting versions, Ovitz was not fired for cause simply because Eisner wanted to protect his personal reputation at the expense of shareholder interests or, worse, because Eisner and Ovitz cynically plotted to transfer millions from shareholders’ pockets to Ovitz’s.112 The Chancellor rejects these versions: Ovitz actually made some positive contributions to the company, he tells us, 107. See Disney, 907 A.2d at 762 (“[C]onsiderations of improper motive are no longer present in this case.”). 108. This is another point that the media coverage ignored prior to the verdict and embraced after the verdict. See, e.g., Kim Christensen & Richard Verrier, Judge Rules in Favor of Disney in Ovitz Case but Criticizes Eisner, L.A. TIMES, Aug. 10, 2005, at A1 (“Ovitz’s 1995 hiring was hailed at the time as a coup for Disney and Eisner . . . . Ovitz was a near-mythical figure then, frequently dubbed Hollywood’s most powerful executive . . . .”). 109. Disney, 907 A.2d at 713-14; Christensen & Verrier, supra note 108 (emphasizing the mismatch-in-cultures point). 110. See, e.g., Frankel, supra note 64, at 358 (“[The Chancellor made Ovitz] look like an incredibly stupid man, who [was] inexperienced in the politics of corporate Holly- wood. . . . [T]his description undermines Ovitz’s reputation more than any criticizing of his behavior would. . . . He was the punished bad boy . . . .”). 111. See supra note 91. 112. See, e.g., Bruce Orwall & Joann S. Lublin, Fading Magic, WALL ST. J., Mar. 1, 2004, at A1; James B. Stewart, Partners, NEW YORKER, Jan. 10, 2005, at 46, 53 (suggesting that Eisner foresaw the failure five weeks into Ovitz’s hiring). 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 35 Aside from illustrating how the scolding of individuals does not necessarily translate into reputational damages to the company, Disney also generates a much more counterintuitive observation: judicial comments do not automatically translate into reputational damages to the individual either. The reputational outcomes to the individual depend, again, on the baseline and the type of sin for which the individual is scolded. To illustrate, let us consider Chancellor Chandler’s treatment of Ovitz. The baseline—the pre-verdict reputational capital of Ovitz—was close to zero. When legal scholars claim that the verdict humiliated Ovitz by presenting him as a powerless whipping boy,125 they ignore the fact that these depictions were already publicly available and widely accepted in the court of public opinion.126 The verdict could not have reduced Ovitz’s already deflated reputational capital by much (if at all). In fact, the Chancellor’s narrative resembles (and thus lends credence to) the narrative that Ovitz himself promoted in an attempt to recover his lost reputation.127 Unsurprisingly so: it is better for Ovitz to be perceived as powerless or incompetent in a given task than as someone who cynically disregards shareholder interest or is inherently useless. As one Wall Street Journal columnist quipped: “if Mr. Ovitz does not come out smelling like a rose, he at least gets some of his reputation back.”128 * * * Overall, the Disney litigation illustrates how judicial comments do not automatically translate into an increase in reputational sanctions. To the extent that the verdict impacted stakeholders’ beliefs, it probably convinced them that Disney’s problems are less deep-rooted and more easily fixable than they previously thought. This is not to suggest that the litigation was all fun and games for the defendants. In fact, it probably was a nightmare for them. After all, they were dragged through discovery and cross-examinations, and some of them were publicly scorned by the judge. But remember that from a strengthening of corporate governance. See Kim Christensen, Disney Board Gives Shareholders More Clout, L.A. TIMES, Aug. 19, 2005, at C2; Kim Christensen, Disney Chief Brings Calm to Firm Famed for Discord, L.A. TIMES, Sept. 28, 2005, at A1; Laura M. Holson, Disney Renovation: A Master Plan to Restore the Kingdom’s Magic, N.Y. TIMES, Aug. 15, 2005, at C1. 125. See, e.g., Frankel, supra note 64. 126. See ERIC DEZENHALL, NAIL ’EM! 128-38 (1999); Dominick Dunne, Sorcerer’s Apprentice, VANITY FAIR, Feb. 2005 (“Ovitz is probably the most humiliated Hollywood figure of the last decade.”); Orwall & Bray, supra note 95 (“[Ovitz] seemed intent on using the witness stand as a platform to repair a reputation that has taken a beating since he left Disney.”). 127. Compare SLATER, supra note 89, at 328, and Orwall & Bray, supra note 95, with In Re The Walt Disney Co. Derivative Litig., 907 A.2d 693, 716 (Del. Ch. 2005). 128. See Holman W. Jenkins, Jr., Beavis and Butt-Head, Revisited, WALL ST. J., Aug. 17, 2005, at A11; see also Christensen & Verrier, supra note 108 (“Chandler’s decision provides some comfort for Ovitz, who had sought to use the case to finally tell his side of the story publicly.”). 36 STANFORD LAW & POLICY REVIEW [Vol. 26:1 reputational perspective, Disney and its managers took a lot of criticism for the Ovitz debacle prior to the verdict. Once the verdict got out, it actually silenced some critics by giving a more nuanced and contextual version, allowing the company to turn over a new leaf. And the parts of the verdict that fueled new criticism were directed at individuals who no longer were part of the incumbent management.129 3. Lost in Translation: Additional Comments on Information Flows The Disney case study offers many insights about how information from courtrooms flows into the market, beyond the big-picture lessons we have covered thus far. This Subpart elaborates on two extra takeaway points: how different types of intermediaries cover verdicts differently and how companies try to control information flow. a. Different Types of Intermediaries Cover Verdicts Differently Information from the courtroom does not simply fall on stakeholders like manna from the sky. Information flows through intermediaries who select what parts to highlight and then add their own take. Three types of intermediaries play an especially important role in transmitting information from corporate litigation: business media, “regular” media, and law firms. Analyzing the coverage of Disney suggests that each type of intermediary chooses to highlight different aspects of the verdict. Media coverage differed from law firms’ memos by putting more emphasis on judicial comments and less on legal doctrines. The Chancellor’s vivid descriptions of how things happened featured prominently in newspaper coverage, but not in law firms’ memos. Law firms took an all-rules approach in their memos to their clients. They emphasized what the decision meant for directors facing a similar hiring and firing decision (that is, what decision- making process future directors need to adopt in order to avoid legal liability). Even among media outlets, there were clear differences in the tone and scope of coverage. The business media’s coverage was more favorable to Disney than was regular media’s coverage. Business newspapers painted the verdict as delivering a victory for Disney and its directors130 and associated the bad parts 129. The Chancellor’s interpretation bears similarity to the way in which companies typically explain their own misconduct: attributing the problem to external and uncontrollable conditions, or to rogue elements that were purged. See Sjoval & Talk, supra note 17, at 271. 130. See Bruce Orwall & Merissa Marr, Judge Backs Disney Directors in Suit on Ovitz’s Hiring, Firing, WALL ST. J., Aug. 10, 2005, at A1; Christopher Parkes, Disney Board in the Clear Over Firing of Ovitz, FIN. TIMES (Aug. 10, 2005; 3:10 AM), http:// www.ft.com/intl/cms/s/0/c3768dc2-093b-11da-880b-00000e2511c8.html#axzz3SzdkhtCI. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 37 of the verdict (caustic criticisms) almost solely with the retiring Eisner.131 Regular newspapers, by contrast, painted the verdict as delivering crushing criticism to everyone involved.132 Such variation in the coverage of verdicts translates into variation in reputational outcomes. The reputational outcome depends on who the target audience is and what intermediary is being tapped for information by the audience. Roughly speaking, the reputational outcomes for Disney were zero for audiences relying on law firms’ coverage; negative for audiences relying on regular newspapers; and mixed (or even positive) for audiences relying on business newspapers.133 Future analyses of the reputational impact of litigation thus should acknowledge that reputation is multifaceted and distinguish between different types of audiences.134 b. Companies Affect the Information Flows from the Courtroom The verdict was not the only newsworthy event affecting Disney’s reputation at the time. Disney actually timed the issuance of a quarterly report to the exact day of the verdict’s release, announcing strong earnings growth.135 The company’s seemingly unrelated press release drew some of the media’s attention away from the verdict. The positive announcements got comingled and presented together with the verdict as a “good day overall for Disney.”136 131. See, for example, the titular claim of Christopher Parkes, Eisner’s Disney Reign Cut Down in Court: Although the Outgoing Chief Executive Was Not Found Guilty of Fiduciary Neglect, His ‘Machiavellian’ and ‘Imperial Management Style’ Was Put Under the Spotlight, FIN. TIMES (Aug. 15, 2005, 5:14 PM), http://www.ft.com/cms/s/1/38d063d2- 0cdd-11da-ba02-00000e2511c8.html#axzz3SzdkhtCI. 132. Compare the opening sentences in the front-page stories of The Happiest Board on Earth, supra note 101; White, supra note 117; and Regulating Fantasyland, supra 103; with Jenkins, supra note 128; and Parkes, supra note 130. 133. The reputation literature suggests that media coverage makes stakeholders change their attitudes towards a company only when the coverage is predominantly negative; a mixed coverage does not increase reputational sanctions. Rebecca Reuber & Eileen Fischer, Organizations Behaving Badly: When Are Discreditable Actions Likely to Damage Organizational Reputation?, 93 J. BUS. ETHICS 39, 45-46 (2010). The Disney verdict coverage contained some unfavorable quotes but also some favorable themes and was overall mixed. 134. Any analysis of reputational impact should ask “reputation to whom?” and “for what?” Companies and businesspeople may exit litigation with a stellar reputation among one group of stakeholders but a tarnished reputation among another. 135. See THE WALT DISNEY CO., THE WALT DISNEY COMPANY REPORTS RESULTS FOR THE QUARTER AND NINE MONTHS ENDED JULY 2, 2005 (Aug. 9, 2005), available at http://the waltdisneycompany.com/sites/default/files/press-releases/pdfs/2005-08-09%20Earnings.pdf. 136. See Kate Kelly, Disney Earnings Jump on Gains from TV Division, WALL ST. J., Aug. 10, 2005, at A3 (“Disney’s upbeat earnings announcement came on the heels of another victory for the company: a Delaware judge’s ruling that Disney’s directors didn’t breach their fiduciary duty . . . .”); Steiner, supra note 123 (“[H]ours after [Chandler’s] ruling all eyes from Wall Street were on the media group’s stellar third-quarter results.”). 40 STANFORD LAW & POLICY REVIEW [Vol. 26:1 Secondly, in Caremark too the Chancellor’s version is actually favorable to the company when compared with how market and social arbiters previously interpreted the events. Chancellor Allen spends most of his opinion emphasizing how Caremark’s problems resulted from rogue, mid-level employees (who were subsequently fired) rather than from systematic breakdowns. He describes in detail how Caremark’s directors were proactive in their efforts to stop the problem once they recognized it.148 Here, too, the Chancellor’s narrative comes close to something a company’s spokesperson would dictate: acknowledging a problem but isolating and localizing it, thereby assuring stakeholders that the likelihood of future debacles is low. IV. IMPLICATIONS: THE INDIRECT DETERRENCE FUNCTION OF DELAWARE CORPORATE LAW A. How Key Doctrines Contribute to Information Production If we agree that reputation matters in the corporate world and that the legal system affects reputation, then we need to reevaluate legal institutions by factoring (inter alia) how they contribute to the production of high-quality information. The need to reevaluate key features of corporate law along these lines is emphasized by the corporate legal scholarship conundrum: most scholars assume that the primary function of corporate litigation is deterrence,149 yet we have not yet fully developed answers on how to evaluate deterrence. Existing accounts often assume that deterrence can simply be measured through the outcomes of verdicts—through looking at the imposition of legal sanctions. The saints and sinners approach adds the angle of measuring deterrence also through the content of verdicts—through looking at indirect deterrence through moralistic comments. My analysis, by contrast, does not limit itself to the outcomes or content of verdicts. I propose to consider also indirect deterrence through information production (reputational sanctions), which occurs throughout the process. This shift in perspective—adopting the informational and reputational lens—offers unique insights into key procedural and substantial doctrines in Delaware corporate law. 1. Procedural Doctrines: Pleading Mechanisms and Settlement Approvals The most basic implication from acknowledging the information production role of litigation is that procedure matters. Most academic corporate law analyses revolve around substantive doctrines. We debate endlessly the 148. Id. at 962-63, 971. 149. See Darian M. Ibrahim, Individual or Collective Liability for Corporate Directors?, 93 IOWA L. REV. 929, 952 (2008) (compiling references). 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 41 nuances of what standard of review applies to given sets of circumstances. But in reality, procedural doctrines shape corporate behavior at least as much. a. The Pleading Stage Think for example about the “good faith” doctrine and its impact on corporate behavior. Countless analyses of the Disney litigation touted Chancellor Chandler’s treatment of the duty of good faith as holding the promise to revolutionize corporate law. From now on, scholars told us, the enforcement of fiduciary duties will be ratcheted up: Delaware courts will not confine themselves to sanctioning just extreme cases of conflicted interests (duty of loyalty) or recklessness (duty of care); they instead will use the flexible duty of good faith to scrutinize a much wider array of misgovernance, including over-deference to the CEO.150 In retrospect, we know that the duty of good faith did not deliver on its presumed promise: courts still refrain from imposing sanctions on directors.151 But it would be a mistake to suggest that the good faith notion did not make a difference for enforcement. Sure, good faith may not have altered the legal outcomes of Delaware litigation, but it did shape enforcement indirectly, through allowing for more relevant information production in the process of litigation. Good faith is best seen not as a substantive doctrine but rather as a pleading mechanism.152 Following the enactment of section 102(b)(7) of the Delaware General Corporation Law, most Delaware companies put in their charter an exculpatory provision shielding directors from claims of mismanagement. As a result, most lawsuits used to have trouble surviving motions to dismiss. Good faith then emerged as an antidote to the pleading gambit of defendants: when plaintiffs manage to frame their complaint in ways suggesting bad faith, they stand a chance of advancing to discovery. And once a case proceeds to discovery, the horses are out of the barn; it is in discovery where most reputation-relevant information is produced. Through discovery, the legal system manages to tell market players things they do not already know about the company and businesspeople. So even though the threat of legal sanctions stays the same—most Delaware cases still settle, and in the few that do not, defendants win—the threat of reputational sanctions gets a boost from the liberal use of good faith to advance cases beyond the pleading stage. The point here goes beyond the doctrine of good faith. A liberal use of pleading mechanisms in cases against big-firm defendants is crucial if a legal system wishes to produce reputation-relevant information. Delaware fits the bill 150. Gordon, supra note 32, at 1489 n.88. 151. See Hill & McDonnell, supra note 70, at 371-72 (recounting the rise and fall of the good faith doctrine as the great white hope of increased legal enforcement). 152. See Hillary A. Sale, Good Faith’s Procedure and Substance: In re Caremark International Inc., Derivative Litigation, in THE ICONIC CASES OF CORPORATE LAW 279 (Jonathan R. Macey ed., 2008). 42 STANFORD LAW & POLICY REVIEW [Vol. 26:1 nicely: it uses a lax standard of review when determining whether to impose legal sanctions but a more stringent standard of review in the pleading stage. In other words, Delaware courts let big cases proceed to discovery and trial even when the odds that these complaints will ultimately win are slim. This is the essence of famous doctrines such as Zapata,153 which applies an enhanced standard of review to the special litigation committee conduct, or Kaplan,154 which makes the question of how much discovery to accord to plaintiffs a matter of court discretion. Delaware decisional law therefore is geared towards flushing out disputes. While courts usually defer to the business judgment of directors, they gladly interfere when directors use their judgment to stifle litigation.155 b. The Settlement Stage Another example of procedural mechanisms that affect corporate behavior (without being appreciated for doing so) comes from the body of practices and doctrines on how to treat settlements. The overwhelming majority of legal disputes settle, so the reputational outcomes of litigation depend on what information emerges from settled cases. The quantity and quality of information production in settlements is a function of when the case was settled. If courts allow cases to proceed beyond pleading and to discovery, reputation-relevant information may emerge even when the case is settled before trial. The legal system also shapes the reputational outcomes of cases after they settle, through various channels. Most basically, the issue of settlements’ secrecy is paramount to information production; the parties have incentives to keep settlements secret, but the public may have an interest in openness. If litigation produces an informational public good, then secret settlements are a public bad.156 Another issue concerns judicial approval of settlements. Because most corporate disputes are filed as class and derivative actions, most settlements are subject to judicial approval. As a result, Delaware judges get an opportunity to voice their opinion—to give their own version of how things happened—even 153. Zapata Corp. v. Maldanado, 430 A.2d 799 (Del. 1981). 154. Kaplan v. Wyatt, 499 A.2d 1184 (Del. 1988). 155. Delaware’s approach stands in contrast to that of other jurisdictions such as New York, which defer to special litigation committees. See WILLIAM T. ALLEN ET AL., COMMENTARIES AND CASES ON THE LAW OF BUSINESS ORGANIZATION 392 (4th ed. 2012); see also Kuykendall, supra note 143 (arguing that Delaware’s pleading standards contribute to the ability of judges to produce texts). 156. See Steven Shavell, The Fundamental Divergence Between the Private and the Social Motive to Use the Legal System, 26 J. LEGAL STUD. 575, 605 (1997). To be sure, information production is just one factor to consider among many, and it is hard to assess all the ex ante effects of barring secret settlements. My purpose here is not to categorically advocate against secret settlements, but rather to introduce previously overlooked costs and benefits that should be taken into consideration. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 45 litigation, and a lot of litigation creates overdeterrence of market activities.164 But if litigation indeed generates a positive externality of credible reputation information, then litigation intensiveness is not necessarily a bad thing. In other words, intensive litigation does not necessarily create overall overdeterrence. Sure, intensive litigation may create legal overdeterrence, but at the same time it mitigates market overdeterrence. Secondly, reliance on open-ended standards also contributes to the quality of information production through shaping the richness and relevancy of judges’ verdicts. When judges rely on flexible doctrines such as good faith, they are relatively free to select the facts and create a version of the events that they deem most relevant.165 Moreover, an analysis that focuses on good faith notions emphasizes reputation-relevant distinctions, such as whether directors’ misconduct was intentional or whether the problems that directors should have monitored are deep-rooted.166 B. How the Content of Corporate Law Is Determined: A “Make It Look like a Struggle” Theory Shifting our focus from legal outcomes (direct deterrence) to nonlegal outcomes (indirect deterrence) necessitates a reevaluation of the endless debate on how the content of corporate law is determined—on whether state corporate law is a race to the top, to the bottom, or not a race at all. Those who subscribe to a saints and sinners approach usually advocate against a race-to-the-bottom view. The main argument of the saints and sinners approach, after all, has a normative flavor: it calls for a shift of focus from how seldom legal sanctions are imposed to how many nonlegal sanctions are inflicted (through judicial sermons).167 Such a description of Delaware law is hard to reconcile with a race to the bottom: why should a race-to-the-bottom judge dress down and inflict nonlegal pain on incumbent managers?168 The 164. See Lucian Bebchuk & Assaf Hamdani, Vigorous Race or Leisurely Walk: Reconsidering the Debate on State Competition over Corporate Charters, 112 YALE L.J. 553, 601-02 (2002) (compiling references). 165. Here again Disney serves as a case in point: Chancellor Chandler’s reliance on good faith allowed him to convey a fact-intensive, coherent narrative in a way that could not have happened had he couched the legal questions as concerning strictly loyalty or care. See Sean J. Griffith, Good Faith Business Judgment: A Theory of Rhetoric in Corporate Law Jurisprudence, 55 DUKE L.J. 1, 22-23 (2005). 166. See Hillary Sale’s analysis of the Caremark case, supra note 152, at 292, on the issue of what standards apply to directors’ duty to identify red flags. 167. See Fairfax, supra note 47, at 445 (“[Saints and sinners] scholars argue that legal opinions obviate the need for legal sanctions because communities rely on the norms articulated by such opinions to regulate director conduct.”). 168. To use Disney as illustration: a state that is racing to the bottom and is captured by corporate America could have thrown away the complaint at the motion to dismiss stage; or at least refrain from humiliating directors with caustic judicial commentary. See Macey, supra note 74, at 1134. 46 STANFORD LAW & POLICY REVIEW [Vol. 26:1 infliction of nonlegal pain is seen in this version as proof that judges do not cater to managers. I want to offer here an alternative perspective. While I agree that Delaware decisional law generates nonlegal sanctions, I think that the saints and sinners proponents miss a crucial distinction between perceived sanctions and real sanctions. When legal enforcement is done indirectly (through scolding), it becomes far less transparent than when it is done directly (through legal sanctions). The public can easily assess how much a $100 million fine hurts a company. But the public has a hard time assessing how much verbal scolding actually hurts a company or individual. The reliance on judicial scolding creates a wedge between perceived and real enforcement. This wedge, in turn, allows Delaware to be perceived (by the public and Washington) as tougher on corporate America than it actually is. My argument starts from a general assertion: under certain plausible conditions, it makes sense for a captured regulator to scold his capturers (regulated entities) in public. If Delaware judges do indeed cater to corporate America, then it is in the interests of both sides to be perceived as fighting each other. The emphasis here is on perceived as. If Delaware really fights and hurts corporate America, it risks losing incorporation fees. If, on the other hand, Delaware is perceived by the public as not fighting corporate America at all, it risks a political backlash and eventually getting overruled by Washington.169 To be perceived as enforcing without really enforcing, the enforcer has to adopt low-visibility favoritism: to treat managers favorably but not openly favorably. In other words, both the regulator and the regulated industry want to “make it look like a struggle.” We all know what “make it look like a struggle” means, even if we are unfamiliar with the exact term. We have seen it played out in countless films or novels.170 The story is simple: our hero is captured by some bad guys. The guy who guards our hero, however, wants to let him escape. The problem is that the guard does not want the other bad guys to think of him as a traitor (in our terminology, as catering to the hero). As a result, the hero and the guard come to an agreement: “give me a black eye to make it look like a struggle”/“knock me out with a blow to the head”/“trash the room to make it look like a burglary.” You get the idea. And you probably also get the analogy: Dela- ware—or any other state trying to remain on top of a regulatory race—needs to find a method for being perceived by the public and Washington as delivering vicious blows to corporate America while not really hurting companies. And 169. See Mark J. Roe, Delaware’s Competition, 117 HARV. L. REV. 588 (2003) (arguing that any state that wins the regulatory competition is subject to the risk of being overruled by Washington). 170. See multiple examples of the make-it-look-like-a-struggle trope in the online wiki page for tropes: TV Tropes Found., LLC, Make It Look Like a Struggle, TV TROPES, http://tvtropes.org/pmwiki/pmwiki.php/Main/MakeItLookLikeAStruggle (last visited Feb. 27, 2015); Telephone Interview with Shai Biderman, Professor in the Film and Television Dept., Tel Aviv University (May 21, 2013). 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 47 judicial scolding makes for an effective low-visibility favoritism method, for several reasons. First and foremost, scolding is salient to the public. As the Disney case study illustrates, mass media highlights caustic comments much more than it highlights the nuances of judicial decisions and legal doctrines. Scolding grabs headlines. The result is a public perception of Delaware judges being fed up with corporate America and going after the bad corporate villains. Such a public perception reduces the chances of political backlash, keeping Washington at bay and maintaining Delaware’s powers. However, what bystanders view as an all-out attack on corporate America actually is not that hurtful to those who are being attacked. Recall our discussion of typical scenarios where scolding is directed at already ousted individuals, or targets less reprehensible sins. Second, scathing commentary makes a good make-it- look-like-a-struggle tool because its damage is easily reversible. Scolding is a more flexible enforcement tool than are legal sanctions because it has no precedential value. When judges respond to a wave of corporate scandals by imposing more liability, they somewhat constrain their future behavior by creating precedents. By contrast, when judges ratchet up (perceived) enforcement via caustic comments, they can easily reverse the enforcement intensity once the economy is better and public attention drifts away from corporate governance.171 The point about reversibility also illustrates, more generally, why enforcement through scolding may be good for Delaware companies as a group. A given company or director that suffers uninsurable reputational damage probably hates judicial scolding (ex post). But ex ante, Delaware companies and businesspeople as a group are better off with scolding than with legal liability because scolding allows the enforcer not to commit to harsh responses down the road.172 It makes favoritism more sustainable. As with any other theory about Delaware’s motivations, it is hard to offer conclusive proof that Delaware judges intentionally pursue a make-it-look-like- a-struggle strategy. What I can offer in support of my hypothesis (aside from logic) is circumstantial evidence, such as the explanations that Delaware judges themselves give. For example, when Chancellor Chandler was asked whether his Disney decision proves that Delaware courts are too favorable to corporate defendants, he responded: “how come, then, I get attacked on all sides? . . . maybe that’s the best measure that I’m doing right.”173 To me, such an answer indicates that even if Chandler does not intentionally try to make it look like a struggle, he is aware of the dynamics. Delaware judges understand that the best 171. Cf. Griffith, supra note 165; Jones, supra note 74, at 500; Wilson, supra note 76, at 505-06. 172. Cf. Kuykendall, supra note 143, at 599. 173. See Roy Harris, Delaware Rules, CFO MAGAZINE (Aug. 1, 2006), http://ww2.cfo.com/risk-compliance/2006/08/delaware-rules. 50 STANFORD LAW & POLICY REVIEW [Vol. 26:1 center of national attention.188 A heated debate ensued over the effectiveness of SEC enforcement and the proper scope of judicial review. Those who argue against current SEC-settlement practices (and consequently are in favor of enhanced judicial scrutiny) typically claim that the SEC plays favorites with big-firm defendants, allowing them to get off with small fines and not admitting wrongdoing. The SEC and opponents of enhanced judicial scrutiny counter with two types of arguments.189 First, they claim, there is nothing wrong with the amount of awards collected in settlements. When evaluating whether the collected amount makes sense, one needs to consider the alternative to settling: wasting limited resources on a costly litigation while risking not proving violations and collecting nothing. Second, the SEC claims, SEC settlements contribute to sanctioning and deterrence not just through imposing fines but also through producing information. The SEC announces settlements with a press release that details the allegations, thus putting market players on notice about how the defendants behaved. And since defendants are barred from denying the allegations,190 the SEC’s version goes uncontested and is considered reliable. In this Article, I focus only on the second type of arguments: evaluating whether SEC settlements do indeed inform market participants about wrongdoing. I leave aside the first type of arguments not only because of scope but also because I think that there is no real reason to question the SEC’s official line.191 The SEC has incentives to maximize the amounts it collects even without judicial scrutiny because this is how the SEC’s monitors—in the press, Congress, or academia—measure its success.192 Take the Citigroup case as an example. The absolute maximum that the SEC could have collected had it fought and won a trial is $320 million;193 the amount that the SEC got in settlement was $285 million. The SEC did not leave money on the table with Citigroup. It rarely does.194 Moreover, federal judges are not well positioned to decide questions such as whether to settle and for how much: such decisions 188. See Dreilinger, supra note 187, at 2-3 (providing examples of intensive media coverage); Examining the Settlement Practices of U.S. Financial Regulators: Hearing before the Comm. On Fin. Services, 112th Cong. 2 (2012). 189. See Brief for Appellant at 14-15, 19, 24, SEC v. Citigroup Global Mkts., Inc., 673 F.3d 158 (2d Cir. 2012) (No. 11-5227) [hereinafter SEC’s Brief]; Robert Khuzami, Remarks Before the Consumer Federation of America’s Financial Services Conference, U.S. SECURITIES AND EXCHANGE COMMISSION (Dec. 1, 2011), available at http://www.sec. gov/news/speech/2011/spch120111rk.htm. 190. 17 C.F.R. § 205.5 (2014). 191. Another good reason to focus on the indirect outcomes of SEC settlements is that most commentators have focused solely on direct outcomes—the severity of fines obtained. See David M. Becker, What More Can Be Done to Deter Violations of the Federal Securities Laws?, 90 TEX. L. REV. 1849, 1867 (2012). 192. See MACEY, supra note 32, at 13. 193. See SEC’s Brief, supra note 189, at 50-51. 194. See Danné L. Johnson, SEC Settlement: Agency Self-Interest of Public Interest, 12 FORDHAM J. CORP. & FIN. L. 627, 661, 672 (2007); MacDonald, supra note 179, at 427. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 51 require not only factoring the particulars of the case at hand but also prioritizing the budgetary constraints and caseload pressures of the SEC.195 On the other hand, we have plenty of reasons to question the SEC’s claim that its settlements provide useful information. They do not. The next Subpart explains why. B. Identifying the Problem: How SEC Settlements Underproduce Information The SEC’s argument about the informative value of settlements misses an important distinction between the quantity and quality of information. More information does not necessarily translate into a better information environment. The SEC is right to suggest that its settlements produce more information than other settlements—as is manifested in summarizing the allegations in press releases and making detailed complaints available. But the information that the SEC typically releases is not reputation-relevant. It does not help market players distinguish between good and bad actors. In order for SEC settlements to impact market players’ beliefs and facilitate better reputational sanctioning, they have to provide new facts or credible interpretations. The typical SEC settlement fails to do that for several reasons.196 First, putting the public on notice is helpful only if the public has not already noticed the wrongdoing. When the wrongdoing is done on a large scale and by visible companies, the media usually covers it long before the SEC releases information.197 In the Bank of America settlement announcement, for example, every piece of information was stale.198 The informative value of putting the public on notice thus depends on the baseline. The notice has an informative value in actions against small broker-dealers, where but for the SEC announcement the violation would not have been noticed. Conversely, notice by itself has little informative value in settlements of the Bank of America and Citigroup kind, where the public had already noticed that something wrong had happened and the role of the SEC was to focus on explaining how exactly things went wrong: What specific control weaknesses 195. See SEC’s Brief, supra note 189, at 43; Sanford Weisburst, Judicial Review of Settlements and Consent Decrees: An Economic Analysis, 28 J. LEGAL STUD. 55, 67, 98 (1999). 196. See Samuel Buell, Potentially Perverse Effects of Corporate Civil Liability, in PROSECUTORS IN THE BOARDROOM: USING CRIMINAL LAW TO REGULATE CORPORATE CONDUCT 87, 99 (Barkow & Barkow eds., 2011). 197. See Karpoff et al., supra note 29, at 15. 198. Compare Press Release, SEC, SEC Charges Bank of America for Failing to Disclose Merrill Lynch Bonus Payments, (Aug. 3, 2009), available at http://www.sec. gov/news/press/2009/2009-177.htm, with Susan Beck & Andrew Longstreth, All Sides of the Fence, 31 AM. LAWYER 13 (Apr. 2009) (summarizing the media coverage four months prior to the SEC’s release). 52 STANFORD LAW & POLICY REVIEW [Vol. 26:1 led to the wrongdoing? Was it really just a low-level rogue employee or a more pervasive problem? Second, the reputational impact of settlement announcements is further diluted by the SEC’s tendency to target whole industries.199 Announcing that company X allegedly engaged in wrongdoing does not really help market players if all company X’s competitors face similar allegations. Stakeholders cannot take their business elsewhere—cannot dispense reputational sanctions— unless the SEC provides details that distinguish between one alleged wrongdoing and another: which are attributed to technical errors and which reflect more deep-seated issues.200 Third, the SEC often lets defendants shape the content of announcements. Most of the settlements are pre-negotiated, and the SEC lets big-firm defendants minimize the reputational impact in two ways.201 The simultaneous announcement of complaint and settlement limits the negative publicity exposure to only one event. And, more importantly, the pre-negotiation allows defendants to shape the public perception of the SEC’s allegations by affecting the language of SEC announcements. The Citigroup case illustrates how the SEC’s public version is watered down compared to the SEC’s internal version. In Citigroup, the same misconduct (material misstatement) led to two complaints: one against the company and one against an employee (Brian Stoker). Yet for some reason, the language used to describe the misconduct was different. The complaint against the company emphasizes that no bad intentions were involved while the Stoker complaint does indicate intentionality.202 The complaint against Stoker mentions the gross revenues collected by Citigroup in the toxic transaction while the complaint against Citigroup uses only the less damning net-profits figure. Both aspects—the degree of intentionality involved and harm done—are important determinants of reputational sanctions. The framing of the Citigroup complaint therefore limited the reputational damages to the company. Finally, the SEC argues that settlement announcements are informative even without containing admissions, simply because defendants are barred from denying the allegations. But in reality the “no denial” requirement is not (and perhaps cannot be) enforced. The information contained in the SEC allegations is open to interpretation and disagreement, if only because 199. See MACEY, supra note 32, at 225, 236. 200. Id. at 23-24; Jesse Eisinger, Needed: A Cure for a Severe Case of Trialphobia, PROPUBLICA, Dec. 14, 2011, http://www.propublica.org/thetrade/item/needed-a-cure-for-a- severe-case-of-trialphobia (“[The announcement] renders the settlement little more than turning on the light in a kitchen full of roaches. . . . [T]he settlements merely show how the bad actors are scattered everywhere.”); Johnson, supra note 194, at 674). 201. See Johnson, supra note 194, at 665; Dreilinger, supra, note 187, at 12-13. 202. See Brief of Amicus Curiae former SEC General Counsel and Chairman Harvey Pitt in Support of Affirmance of District Court’s Ruling at 26, SEC v. Citigroup Global Mkts., Inc., 673 F.3d 158 (2d Cir. 2012) (No. 11-5227) [hereinafter Harvey Pitt Brief]. 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 55 market players with more credible information on how exactly companies misbehaved. And the SEC should prioritize differently among its enforcement cases—by concentrating resources on cases that produce big informational benefits (disputes with giant financial firms), even at the expense of amassing complaints and litigating against smaller firms or low-level employees. Judicial review, however, is a very imperfect method for improving SEC settlements. Judges themselves are fallible and may interfere even when the SEC makes the right considerations.213 My point here is not to advocate for more judicial scrutiny, but rather for better judicial scrutiny. To the extent that the newfound enhanced judicial scrutiny is here to stay, we need to develop clear guidelines for its application.214 I offer two simple guidelines. First, judges should generally maintain deference to the SEC. Interference raises the costs of settlements and limits the range of mutually beneficial bargains between the regulator and the regulated entities. Second, the main trigger for judicial intervention in rare cases should be information production and not severity of fines. Judges should interfere whenever the settlement withholds quality information on a topic that is of wide interest to the market.215 In fact, the SEC already seems to be trending in the right direction. Under the leadership of Chairman Mary Jo White the SEC changed its settlement policy to require more admissions from certain defendants.216 For example, in September 2013, it announced twenty-three neither-admit-nor-deny settlements with firms accused of short selling,217 and two days later a settlement where JPMorgan not only paid $200 million but also admitted wrongdoing.218 To me, these two announcements represent the right priorities going forward, based on the type of violations and the companies involved. The alleged violation in short-selling cases does not require intent, and the firms involved are not 213. Federal judges enjoy life tenure, but they are not immune from seeking esteem, influence, or promotions. They too may advance their own reputation at the expense of overall welfare. See Fredrick Schauer, Incentives, Reputation, and the Inglorious Determinants of Judicial Behavior, 68 U. CIN. L. REV. 615, 629-33 (2000). 214. See Dreilinger, supra note 187, at 6 n.33. 215. The doctrinal hook for demanding more information production comes from the requirement to consider “the public interest” when reviewing SEC’s decisions. See SEC v. Randolph, 736 F.2d 525 (1984). Note that any form of judicial scrutiny should consider the unintended consequences on parallel private litigation: before making settlements more informative one should consider limiting the issue preclusion and estoppel effects. Buell, supra note 196, at 100-01. 216. See James B. Stewart, S.E.C. Has a Message for Firms Not Used to Admitting Guilt, N.Y. TIMES (Jun. 21, 2013), http://www.nytimes.com/2013/06/22/business/secs-new- chief-promises-tougher-line-on-cases.html?pagewanted=all. 217. See Press Release, SEC, SEC Charges 23 Firms with Short Selling Violations in Crackdown on Potential Manipulation in Advance of Stock Offerings (Sept. 17, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539804376#.U u-8ntGA3IU. 218. See Press Release, SEC, JPMorgan Chase Agrees to Pay $200 Million and Admits Wrongdoing to Settle SEC Charges (Sept. 19, 2013), available at http://www.sec.gov/ News/PressRelease/Detail/PressRelease/1370539819965. 56 STANFORD LAW & POLICY REVIEW [Vol. 26:1 household names. By contrast, when a giant like JPMorgan is charged with misstating financial results and lacking internal controls, it becomes essential that the public gets credible detailed information on how things went wrong. To borrow an analogy from communication science: the SEC needs to shift to a “burglar alarm” mode of reporting. In the past decade, scholars have been advocating a shift from the traditional “all the news that’s fit to print” mode of journalism to a burglar-alarm approach.219 The idea is that nowadays, with the advancement of information technologies, citizens can easily access information on all issues. What citizens need is not more information but rather someone to sift the information for them: a reputable intermediary that will direct citizens’ scant attention to the few pieces of information that are more relevant and critical. The same can be said with regard to SEC settlements. Nowadays market players learn about financial misconduct from multiple sources. The SEC therefore should switch from merely putting us on notice that lots of bad things are happening to flagging the more problematic cases— providing detailed information on the most important cases and directing market players’ attention to instances where they greatly under- or overstated problems. * * * A quick update is in order. In June 2014, shortly after this Article was orig- inally submitted, the U.S. Court of Appeals reached a decision in the Citigroup case, vacating Judge Rakoff’s refusal to approve the settlement.220 Seen from the informational perspective developed here, the Court of Appeals decision sets a bad precedent: it focuses the permissible scope of judicial review on the procedural aspects of the consent decree and explicitly limits the judge’s ability to demand more information on what and how things happened. It remains to be seen how the two recent contrasting trends mentioned above—the SEC’s move toward a more informative approach and the courts’ move toward a less informative approach—will affect the ability of market (reputational) forces to deter misbehavior in securities markets. CONCLUSION This Article makes one overarching point: corporate law shapes behavior not through imposing liability, but rather through producing information. In the course of fleshing out this point and examining the interactions between law and reputation, the Article contributes to various debates that have been at the center of academics’ and practitioners’ attention. In this Part, I offer a brief synthesis of the Article’s contributions as they relate to existing literatures, before outlining future research. 219. See John Zaller, A New Standard of News Quality: Burglar Alarm for the Monitorial Citizen, 20 POL. COMM. 109, 116 (2003). 220. SEC v. Citigroup Global Mkts. Inc., 752 F. 3d 285 (2014). 2015] A REPUTATIONAL THEORY OF CORPORATE LAW 57 First, the Article advances our understanding of how reputational forces work. The Article’s original contribution is not in telling us that reputation matters or that the law matters for reputation,221 but rather in exploring how the law matters for reputation. Specifically, the Article is the first to examine at length the reputation-shaping implications of information that is produced in the process of litigation or regulatory investigations. The existing literature tells us that on average litigation and regulatory investigations are bad for a defendant-company’s reputation, whereas I shed light on the cross-section: why some disputes do not hurt or even help the defendant-company’s reputation. Second, the Article challenges the conventional assumption among law and social norms scholars that the legal and reputational systems are independent of each other.222 The focus on interdependencies between formal and informal systems of control makes this Article closely related to several recent working papers that analyzed the informational role of the law.223 My approach differs from theirs along two dimensions: namely, by examining what gap in market knowledge the legal system is filling, and how it is filling the gap. Firstly, existing accounts assume that market players are not aware of corporate misconduct and that the role of the legal system is to reduce the detection costs of reputational sanctions.224 My account, by contrast, assumes (following recent empirical studies) that in disputes with big-firm defendants, market players become aware of and react to misconduct before the legal system gets involved, so the real role of the legal system is to produce second opinions on how things happened.225 Secondly, existing accounts focus on the informational role of legal outcomes226 while I focus on information disseminated in the process of determining legal outcomes. Two SEC enforcement actions (or Delaware trials) with identical legal outcomes may generate completely different reputational outcomes. Third and most basically, the Article revisits the debate over how corporate law matters. My approach is related to and complements the influential saints and sinners theory. Most notably, I develop the transmission-of-law point that 221. We already knew that. See Karpoff, supra note 4 (providing an overview of the extant empirical literature on the reputational outcomes of enforcement events). 222. See supra note 20 and accompanying text. 223. See Edward Iacobucci, On the Interaction Between Legal and Reputational Sanctions (Jan. 23, 2012) (unpublished manuscript), available at http://ssrn.com/abstract=1990552; Scott Baker & Albert Choi, Reputation and Litigation: Using Formal Sanctions to Control Informal Sanctions (Aug. 20, 2013) (unpublished manu- script), available at http://ssrn.com/abstract=2195749. 224. See also MACEY, supra note 32, at 12; Fairfax, supra note 47, at 443. 225. The reputational impact of litigation therefore depends on the type of misconduct and companies involved, and the identity of harmed parties. Cf. Skeel, supra note 44, at 1864. 226. See Iacobucci, supra note 223 (noting that the size of legal sanctions affects the reputational signaling equilibrium by affecting firms’ initial decisions whether to commit wrongs or not); Baker & Choi, supra note 223 (arguing that firms can opt to submit themselves to formal sanctions and thus facilitate better informal control).