Director's liability and investor protection: a law and finance perspective

This article conducts an analysis of director's liability in listed firms using modern finance theory. The paper describes how the use of special general clauses in Danish law regulates director's liability. It is shown how risk and return combinations may assist in determining whether management has violated the business judgment rule. The analysis shows that this legal doctrine is optimal from an economic perspective. The article introduces the concept of "temporal relatively of the shareholder equality principle" which can be used to determine whether the interests of minority shareholders have been set aside. It is shown that the principle of shareholder equality must be subjected to both an ex ante, as well as an ex post assessment. Moreover, courts should be reluctant to interfere in situations where there has been an unequal distribution of gain (or loss) ex post. The theoretical arguments are illustrated by analyzing a leading Danish court case that involved the squeeze out of minority shareholders in the Danish telecom company. The paper also analyzes the incentive effects of derivate suits and suits commenced by individual shareholders. It is shown that the former creates a free rider problem whereas in the latter situation, shareholders are not fully able to internalize their externalities.