An economic analysis of corporate directors' fiduciary duties

Abstract

I present a principal-agent model where the shareholders (principal) can take legal action against the director (agent). The court's decision provides a verifiable but costly and imperfect signal on the director's fulfilment of his fiduciary duties. The director's remuneration can be made contingent not only on performance but also upon the court's decision. I show that when damage awards are high enough, the widespread use of liability insurance and limited-liability provisions that is observed in the United States is optimal because it allows for a more efficient litigation strategy to be ex post rational for the shareholders.