A reputational theory of corporate law.

Author:Shapira, Roy
Position::III. The Disney Litigation: A Case Study B. Information Produced During Litigation 2. The Real Impact of the Verdict through Conclusion, with footnotes, p. 30-60
 
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  1. The Real Impact of the Verdict

    Now that we understand how the court of public opinion treated the Ovitz affair prior to the verdict, we can turn to analyze what difference the verdict really made. Rereading the decision along with the media coverage of it generates one immediate conclusion: the conventional view that sees the verdict as a reputational deathblow to everyone involved is misguided. Granted, Chancellor Chandler's version contains some quotable caustic comments. But it also provides more nuanced and contextual explanations for the Ovitz debacle. Unlike the prevalent preexisting interpretations of what went wrong in Disney, the verdict attributes the bad outcome to rare external conditions rather than to deep-rooted disregard for market norms. And the Chancellor reserves his strongest criticisms for individuals who were already ousted from Disney, thus implicitly creating a separation between bad (ousted) individuals and a good company. As a result, to the extent that the verdict changed stakeholders' beliefs, it probably pushed stakeholders into thinking more positively about the company and its incumbent management.

    1. Emphasizing the Context

      The Chancellor opens his version with an explanation of the hiring: why Disney's board rushed to hire someone with no experience in running a large public company, and then on top of that, signed an outrageous severance package provision. Here the verdict's version differs from preexisting versions by putting more emphasis on the context. The Chancellor highlights from the outset (and then reiterates constantly) (99) the "perfect storm" that pushed Disney into the Ovitz affair: Disney's previous president died in a helicopter crash; Disney's CEO (Eisner) suffered from a heart condition; and the company was in the midst of major expansions. Due to these unusual circumstances, the company desperately needed a new president to take the burden off the ailing Eisner in the immediate term and to provide an insurance and succession plan for the long run. Targeting Ovitz as the quick-fix made sense at the time, since he was considered Hollywood's number one power broker. (100) And promising Ovitz a hefty severance package was necessary in order to lure him from his previous lucrative position and away from Disney's competitors who were courting him. (101)

      By making the context more salient, (102) the verdict helps stakeholders overcome biases that plague their reputational assessments. Most notably, the Chancellor opens his decision by explicitly warning the readers from hindsight bias: do not ask yourself whether the board's decisions make sense to you now, he tells the reader; ask whether they made sense at the time they were taken. (103) The Chancellor then provides the readers with tools to mitigate their hindsight bias: he extends the timeframe by spotlighting the events that preceded Ovitz's hiring and reminds the reader not to evaluate Disney's management integrity according to twenty-first century best practices (which were not relevant when the Ovitz affair occurred). (104) Most notably, the Chancellor emphasizes that Disney's stock prices jumped through the roof when Ovitz's hiring was announced. (105) Amazingly enough, this important fact was largely missing from the preexisting accounts of the Ovitz affair in the media.

      Emphasizing the context also mitigates the readers' tendency to adopt causal explanations. Remember that the pre-verdict narratives were predominantly causal: if Disney hired an incompetent president only to cushion his way out after a year with $140 million of shareholders' money, then Disney's decision-makers must lack any regard for shareholders' interests, right? (106) Wrong, says the Chancellor. No one in Disney set out to hurt shareholders. (107) In fact, Disney decision-makers--along with the rest of the world, as the stock price reaction indicates--thought that they were creating shareholder value by hiring Ovitz. (108)

    2. Scolding for Honest and Transient Mistakes

      After explaining the hiring, the Chancellor turns to explaining the firing. How come Ovitz performed miserably at Disney? Why was he not fired earlier? Most importantly, why was he not fired "for cause," which could have saved the need to pay his severance package? Here, the Chancellor's answers focus on "mismatch of cultures." Ovitz and the incumbent managers wanted the experiment to work, the Chancellor tells us, but Ovitz simply experienced difficulties assimilating to Disney. Ovitz was flashy, conspicuous, and tried to "agent" his colleagues while the corporate culture was more blue collar and nononsense. (109) Corporate legal scholars viewed the Chancellor's vivid descriptions of the mismatch as humiliating the defendants. (110) But such a view misses two important aspects of reputational sanctions: it ignores the baseline (how does the Chancellor's version compare to preexisting ones?) and the distinction between individual- and organizational-level reputations.

      Attributing the failure to unanticipated mismatches and misperceptions is relatively favorable to the company's reputation. Remember that most preexisting versions talked about how Ovitz's failure was well anticipated: Disney's incumbent management hired an obviously incompetent guy and then intentionally tripped that guy. (111) Moreover, according to the preexisting versions, Ovitz was not fired for cause simply because Eisner wanted to protect his personal reputation at the expense of shareholder interests or, worse, because Eisner and Ovitz cynically plotted to transfer millions from shareholders' pockets to Ovitz's. (112) The Chancellor rejects these versions: Ovitz actually made some positive contributions to the company, he tells us, and neither side was intentionally tripping or foreseeing the failure. (113) At one point the Chancellor describes in detail a seemingly irrelevant tidbit: a company meeting where all the top executives rode the company bus while Ovitz insisted on being chauffeured in his private limo. (114) Legal scholars viewed the inclusion of such a gossipy story as tarnishing Ovitz's reputation. (115) Well, maybe. But how does such a story affect the company's reputation? For stakeholders thinking about whether to interact with Disney in the future, framing the debacle as a story about one greedy executive who did not fit in with the rest of the down-to-earth managers (and was subsequently fired) is not alarming; rather, it is assuring.

      To answer the "scolding for what" question: the Chancellor is scolding Disney and its directors not for calculated disregard for shareholder interests, but rather for honest, temporary mistakes. Prior to the verdict, market and social arbiters framed the Ovitz debacle as a clear-cut story of corporate villains: managers becoming too entrenched and greedy, losing regard for shareholder interests or societal norms. The verdict, however critical of Disney's directors, tells a markedly different story: a story about making mistakes while pursuing shareholder value. (116)

    3. Scolding Individuals Who Were Already Ousted

      Up to now I have focused on how the verdict generates a more nuanced and favorable version. But there are specific parts in the verdict that cannot be viewed as favorable to the defendants' reputation. The Chancellor scolded Eisner for disregarding corporate governance and scolded other top executives for not stepping up and raising red flags. His judicial scolding was done in such a catchable manner and came from such a credible source that it captured front pages of major newspapers, increasing public awareness and recalling attention to the defendants' flaws. (117) But while the reputation-damaging effects of these comments were widely recognized, one aspect of them has been grossly overlooked: the identity of the targets.

      The Chancellor reserved his strongest criticism for six individuals. He laid most of the blame at Eisner's feet (118) and then named three directors who should have done more to prevent the debacle: Irwin Russell, who did not negotiate hard enough on behalf of the company, (119) and two members of the compensation committee--Ignacio Lozano and Sidney Poitier--for not being involved enough. (120) The Chancellor also scolded two nondirectors: Sandy Litvack, the general counsel, for not informing the board on the possibility to avoid paying Ovitz his severance package; (121) and Graef Crystal, an outside expert hired to help the compensation committee, for providing a faulty and incomplete report. (122) All of these six scolded businesspeople have one thing in common: none of them were any longer an integral part of Disney when the verdict was issued. The Disney 2005 board contained many directors who were part of the company in the Ovitz debacle days. Yet none of the retained individuals were scolded. The scolding was reserved for individuals who were already ousted or on their way out.

      The Disney verdict thus illustrates how singling out individuals as sinners may actually help the company. Indeed, the media quickly picked up the scapegoating theme promoted by the verdict. The coverage of the verdict highlighted a contrast: a victory to Disney and its board and a blow to Eisner's scorecard on his way out of the company. (123) More generally, the verdict's singling out of ousted individuals contributed to the company's ability to convince stakeholders that the company had learned from its past and changed its ways. The media and institutional investors bought into the recovery message, presenting Disney as the perfect example of a corporate governance turnaround: the bad company of the 1990s turned into the role model of the 2000s. (124)

      Aside from illustrating how the scolding of individuals does not necessarily translate into reputational damages to the company, Disney also generates a much more counterintuitive observation: judicial comments do not automatically translate into reputational damages to the individual either. The...

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