1.1.1 To punish and not to punish

The impact of directors’ liability is often measured by its enforcement capability and the effects of legal sanction. While some legal scholars have argued the limited effects of legal sanction on directorial behaviour,1 others in contrast, have emphasised the need for legal sanction to hold directors accountable for adherence to their duties. ‘Would-be offenders may be responsive to the reputational sanctions of social censure, embarrassment, and shame that often flow from legal sanctions’.2 Indeed, Fairfax rather challenges those who stay aloof of recognising directors’ liability as a means to accomplish that goal.3 Others contend trust to be pivotal in encouraging directors to serve the interests of their companies responsibly and faithfully. For instance, Blair & Stout argued that legal sanction disrupts trust and prevents directors from activating ‘other regarding behaviour’.4 Ripstein discussed how legal sanction may decrease trust because it introduces grounds for distrust.5 However, distrusting a director is preferred over mistrusting a director.6 Legal sanction may reassure a potential trustor that it is relatively safe to trust and that even in the worst case scenario, he or she will not suffer intolerable high damage.7

In an experiment, Fehr & List8 examined how Chief Executive Officers (CEO’s) respond to the threat of sanction in situations requiring trust and trustworthiness. Interestingly, their research showed that the CEO’s in the study responded in a less trustworthy manner if faced with an explicit threat of punishment. Trustworthiness was shown to be lowest if the threat of sanction was implemented. However, the availability of the sanction threat generated hidden returns: when an actor refrained from the sanction threat, the other person displayed a more trustworthy behaviour than in a situation in which there was no threat at all. Strikingly, trustworthiness was shown to be highest if the threat of sanction was available but not implemented.

The above-mentioned research results provide important insights. I have drawn the following lessons for my own research. First, it is pivotal to understand how directors perceive directors’ liability risks and director protective shields to understand their potential responses to threats of personal liability. Second, the latent potential of legal sanction and the deliberate non-use of legal sanction seem to be of significance to reduce the possibility of opportunistic behaviour on the part of a director. I have appreciated these research findings in their suggestion that directors’ liability legislation, in its potential as a corporate governance instrument, should involve sufficient threat perception on the part of directors while allowing them to reduce excessive risks of litigation; the latter being equally critical to prevent directors from shirking their responsibilities out of fear of being sanctioned.