The effect of Van Gorkom and 102(b)(7)

Larry Ribstein —  23 August 2011

Yaniv Grinstein and and Stefano Rossi have an interesting paper, Good Monitoring, Bad Monitoring, on the effect of corporate law, and specifically of the famous Delaware case Smith v. Van Gorkom and the Delaware legislature’s subsequent “fix” of that result.  Here’s the abstract:

We estimate the value of monitoring in publicly traded corporations by exploiting a natural experiment. A Delaware Supreme Court decision unexpectedly held directors liable for monetary damages for breach of fiduciary duties. The ruling signaled a sharp and exogenous increase in Delaware Courts’ scrutiny over board decisions. We analyze the impact of the ruling on stock returns using matching and differences-in-differences techniques. We find that, compared with appropriately matched non-Delaware firms, Delaware-incorporated firms in high-growth industries lost (CARs of -2.10%) and firms in low-growth industries gained (CARs of 1.40%) in the [0,10] window around the announcement of the Supreme Court decision. A later regulatory reform to the Delaware Code that reversed the effects of the Supreme Court decision had opposite results: firms in high-growth industries gained and firms in low-growth industries lost significantly. Our results shed light on the complex interplay of courts and regulation and on its implications for shareholder value.

In the conclusion the authors state:  “We interpret these results as implying that “one-size-fits-all” models represent inadequate solutions to the corporate governance problem.” In other words, a strict duty of care is good for some companies but not others.

This suggests that firms should be allowed to contract to tailor regulation to their needs. But the Delaware code revision did just that — allow firms to contract.  Yet returns for low-growth firms dropped, despite the fact that the statute allowed these firms to remain subject to the strict care standard.

Does this suggest that corporate contracting is flawed?  Or what?

Larry Ribstein

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Professor of Law, University of Illinois College of Law

3 responses to The effect of Van Gorkom and 102(b)(7)

  1. 

    this is just bunk

    If you plan for a year, plant rice. If you plan for ten years, plant trees. If you plan for 100 years, educate your children

    where are these “companies” today, after 20 years and one Lesser Depression?

  2. 

    Or do the results just reflect the reality that all corporations were almost certain to (and nearly all did) incorporate 102(b)(7) provisions, regardless of whether it was in the best interests of that particular corporation. I guess that’s just an argument that corporate contracting is flawed–the decision was made by directors or promoters, whose interests were skewed in favor of limiting liability to protect themselves, rather than focusing on the best result for the corporation as a whole.
    Very interesting.

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  1. The Impact of Van Gorkom and DGCL Section 102(b)(7) | Attorney and Lawyers - August 28, 2011

    […] lost of Prof. Larry Ribstein with an post there, comes an article of Yaniv Grinstein and and Stefano Rossi entitled: Good Monitoring, Bad […]