This paper studies how the legal liability rules for directors can be optimally designed to provide them with the incentives to fulfill their fiduciary duties and to maximize ex-ante firm value. I present a principal-agent model where the shareholders can obtain a verifiable but costly and imperfect signal on the director's fulfillment of his fiduciary duties by taking legal action against him. This allows the firm to make the director's remuneration contingent not only on performance but also upon the court's decision.The paper shows that, when damages awards are high, the widespread use of liability insurance and limited liability provisions that is observed in the US is optimal because it allows shareholders to credible commit to an optimal suing strategy.
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Paper provided by Centro de Estudios Monetarios Y Financieros- in its series Papers with number
0014.
Length: 61 pages Date of creation: 2000 Date of revision: Handle: RePEc:fth:cemfdt:0014
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Find related papers by JEL classification: G30 - Financial Economics - - Corporate Finance and Governance - - - General K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General
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