The Economics Of D&O Liability For False Information In German Secondary Capital Markets
AbstractIn recent years, the German capital market was shaken by scandals caused by the insiders of public corporations like Comroad, Metabox, Infomatec, EM.TV et al. The overall damages of the scandals generated in the Frankfurt Stock Exchange's Neuer Markt are approximated to be close to 200 billion until the market segment was finally closed down. The consequence of the financial scandals is, besides the causation of the tremendous damages to private investors, a substantially spoiled reputation of the capital market itself, whereas the latter adversities seem not yet to be absorbed completely. Even though the criminal procedures in the mentioned cases leaded to the conviction of the responsible insiders, the refurbishment of the scandals in German courtrooms frequently left damaged investors without a remedy for their losses, thereby revealing the jurisdiction's de lege lata limits. As far as noticed actually none of the damaged investors' civil claims did yet succeed. A first reaction to the corporate scandals by the German regulator in the fourth capital market advancement act is widely assessed to be insufficient to amend investors' legal status effectively. The aim of this analysis is to approach the first best solution to minimize the total social costs of false capital market information. It furthermore contributes to the continuing discussion in Germany about the reasons for the financial scandals. Moreover, it makes a contribution to the debate on the issue, whether the damaging events indicate an advanced intervention of the government, and - if so - in which fashion the legal rule should be developed to be an optimal remedy. The capital market scandals are set off by false capital market information that was intentionally or frivolously disseminated by Directors and Officers (D&O) of public corporations, which are in the German two-tier system Vorstand and Aufsichtsrat. Hence, the impact that false material data have on the efficiency of capital markets will be addressed in detail. Its specific effect on the share price is scrutinized by reviewing practical cases that occurred recently in Germany. This might allow a deeper understanding of the different kinds of damages that result from the approval of a frivolous disclosure policy by Board members. By changing the perspectives the hypothesis that Board members have clear incentives to provide capital markets with false information will be verified. The analysis will apply especially insights of Law & Economics - as well as from the developing branch of Law and Behavioral Science - to emphasize the issue's discussion in traditional legal scholarship. Moreover, as economic theory indicates, a reason for a government intervention is only given in cases of market failures. Thus, the analysis will determine if the inefficient allocation of investors' funds and the related Pareto suboptimality is grounded on market failures. Especially presumable obstacles with asymmetric information, negative externalities and potential free riding-behavior by competitors appear worthwhile to focus on. From an economic perspective it is to discuss whether the damages of shareholders that - due to false capital market information - purchased stocks above their actual value, should be recoupable in general. The crucial aspect about influencing the process of disclosure with an effective liability rule is that it could also hinder necessary and valuable truthful information to be available for the market participants. As the economic approach to the law discerns it as a tool to maximize social welfare, the analysis will check whether the drafted German Kapitalmarktinformationshaftungsgesetz (KapInHag) is complying with this prerequisite. It will focus on two aspects that appear crucial for the efficiency of the legal rule. First, the target of the drafted liability rule, i.e. who should be held liable for the dissemination of false information will be focused on. The traditional German liability regime that favors the primary responsibility of the corporation will be depicted and compared with the divergent proposal of the KapInHaG. The main question will be, which liability system provides the optimal setting of incentives for Board members. Second, as the central aspect of a liability rule is the standard of fault that it comprises, it will be analyzed in detail. The German lawmaker suggests in the drafted KapInHag a standard of "gross negligence". Thus, Board members will compensate damaged investors in every case the court in its ex post evaluation will conclude that the disclosure of false information was grossly negligent. The analysis will examine in detail whether the proposal of the KapInHaG is pinpointing the accurate level of deterrence, while assuring that the necessary information will be disseminated courageously and at the perfect time. Therefore it will specially utilize the Business Judgment Rule, an instrument of US corporate law that might be worthwhile to implement also in German capital market law.
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-03-24 (All new papers)
- NEP-LAW-2007-03-24 (Law & Economics)
- NEP-REG-2007-03-24 (Regulation)
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