Private Enforcement of Corporate Law: An Empirical Comparison of the United Kingdom and the United States

• Date: 01 December 2009
• Author: Richard Nolan,Brian Cheffins,John Armour,Bernard Black
• Published date: 01 December 2009
• DOI: http://doi.org/10.1111/j.1740-1461.2009.01157.x

Private Enforcement of Corporate Law:

An Empirical Comparison of the United

Kingdom and the United Statesjels_1157687..722

John Armour, Bernard Black, Brian Cheffins, and Richard Nolan*

It is often assumed that strong securities markets require good legal protection of minority

shareholders. This implies both “good” law—principally, corporate and securities law—and

enforcement, yet there has been little empirical analysis of enforcement. We study private

enforcement of corporate law in two common-law jurisdictions with highly developed stock

markets, the United Kingdom and the United States, examining how often directors of

publicly traded companies are sued, and the nature and outcomes of those suits. We find,

based a comprehensive search for filings over 2004–2006, that lawsuits against directors of

public companies alleging breach of duty are nearly nonexistent in the United Kingdom.

The United States is more litigious, but we still find, based on a nationwide search of court

decisions between 2000–2007, that only a small percentage of public companies face a

lawsuit against directors alleging a breach of duty that is sufficiently contentious to result in

a reported judicial opinion, and a substantial fraction of these cases are dismissed. We

examine possible substitutes in the United Kingdom for formal private enforcement of

corporate law and find some evidence of substitutes, especially for takeover litigation.

Nonetheless, our results suggest that formal private enforcement of corporate law is less

central to strong securities markets than might be anticipated.

*Address correspondence to John Armour, University of Oxford, Oriel College, Oxford OX1 4EW, UK; email:

john.armour@law.ox.ac.uk. Armour is Lovells Professor of Law and Finance, Faculty of Law and Oxford-Man Institute

for Quantitative Finance, University of Oxford; Black is Hayden W. Head Regents Chair for Faculty Excellence,

University of Texas Law School, and Professor of Finance, University of Texas, Red McCombs School of Business;

Cheffins is S.J. Berwin Professor of Corporate Law, Faculty of Law, Cambridge University, UK; Nolan is Reader in

Corporate and Trust Law, Faculty of Law, Cambridge University, UK.

We are grateful to Michelle Harner, Ed Morrison, Bob Thompson and an anonymous JELS referee for comments,

and to participants at the Yale-Oxford conference on Shareholders and Corporate Governance, the American Law &

Economics Association Annual Meeting 2008, the Conference on Empirical Legal Studies 2008, ECGI Best Paper

Competition Conference 2008, and seminars at the Bank of Italy, Cambridge, London School of Economics, Lovells

LLP, Oxford, Sussex, and the University of Western Ontario for comments following presentations. The extensive

data-collectioneffort for this study merits more than the usual thanks to the RAs who did the collecting and data analysis

for this article and a related paper on securities law: Priya Adhinarayanan, Jennet Batten, Douglas Campbell, Ashwin

Cheriyan, Michael Crnich, Tim Gerheim, Brian Giovaninni, Pierre Grosdidier, James Hawkins, Caroline Hunter,

Graham McCall, Stephen McKay, Craig Morrison, Louisa Nye, Myungho Paik, Ji Min Park, Patrick Robbins, Cephas

Sekhar,Michael Sevel, Lei Sun, Ryan Tarkington, and Adam Wright. We thank Chief Registrar Baister for his invaluable

assistance in connection with our survey of court filings in the United Kingdom. We also thank the Millstein Center for

Corporate Governance and Performance at Yale University for financial support.

Journal of Empirical Legal Studies

Volume 6, Issue 4, 687–722, December 2009

687

I. Introduction

Nearly a century ago, Roscoe Pound memorably drew attention to the divide between “law

in books” and “law in action.”1The distinction between substantive legal doctrine (“law in

books”) and enforcement (“law in action”) is emerging as an important element in an

ongoing debate about the extent to which law explains differences in financial markets

around the world. Beginning in the late 1990s, a group of financial economists known

collectively as “LLSV” reported in a series of widely cited studies that corporate and

securities laws that protect minority shareholders are associated with deep and liquid

securities markets and diffuse share ownership.2This research focused almost entirely on

“law in books.” Enforcement—whether by public agencies or private individuals, whether

civil or criminal, or whether through formal lawsuits or more informal channels—was left

to one side.3

The “law in action” gap is particularly striking because of lively cross-country debate

on the value of private lawsuits against company directors. Many in Europe, keen to expand

domestic capital markets and improve corporate governance, view stronger private enforce-

ment as desirable, and are seeking to change the procedural rules that inhibit private suits.4

Some in the United States see active enforcement as a core strength of U.S. markets that

helps explain the tendency for firms cross-listed in the United States to trade at higher

prices than similar non-cross-listed firms.5Yet others in the United States lament allegedly

excessive litigation against companies and directors, or worry that lawsuit-friendly rules

1Roscoe Pound, Law in Books and Law in Action, 44 Am. L. Rev. 12 (1910).

2“LLSV” is shorthand for Rafael La Porta, Florencio López-de-Silanes, Andrei Shleifer, and Robert Vishny. See, for

example, Rafael La Porta, Florencio López-de-Silanes, Andrei Shleifer & Robert Vishny, Corporate Ownership

Around the World, 54 J. Fin. 471 (1999); Rafael La Porta, Florencio López-de-Silanes, Andrei Shleifer & Robert

Vishny, Law and Finance, 106 J. Pol. Econ. 1113 (1998); Rafael La Porta, Florencio Lopez-de-Silanes & Andrei

Shleifer, What Works in Securities Laws? 61 J. Fin. 1 (2006).

3In addition, recoding of corporate laws by lawyers has cast doubt on some of the LLSV results. Holger Spamann, The

“Antidirector Rights Index” Revisited, Rev Fin. Studies (forthcoming 2009), available at 〈http://ssrn.com/

abstract=894301〉(finding only a 0.41 correlation between original LLSV index and his own recoding). This criticism

does not extend to these scholars’ later effort to code securities laws.

4See, e.g., Jonathan R. Hay & Andrei Shleifer, Private Enforcement of Public Laws: A Theory of Legal Reform, 88 Am.

Econ. Rev. 398 (1998) (advocating use of private enforcement in transition economies); Guido Ferrarini & Paolo

Giudici, Financial Scandals and the Role of Private Enforcement: The Parmalat Case, in After Enron: Improving

Corporate Law and Modernising Securities Regulation in Europe and the US 159, 194–206 (John Armour & Joseph

A. McCahery, eds., 2006) (advocating increased private enforcement in Italy). But cf. Paul Davies, Davies Review

of Issuer Liability: Final Report (2007), available at 〈http://www.hm-treasury.gov.uk/independent_reviews/

davies_review/davies_review_index.cfm〉(opposing significant expansion in private liability of U.K. issuers for secu-

rities mis-disclosure).

5See, e.g., John C. Coffee, Law and the Market: The Impact of Enforcement, 156 U. Pa. L. Rev. 229–311 (2007); Craig

Doidge, G. Andrew Karolyi & Rene M. Stulz, Has New York Become Less Competitive in Global Markets? Evaluating

Foreign Listing Choices Over Time, J. Fin, Econ. (forthcoming 2009), available at 〈http://ssrn.com/abstract=982193〉

(foreign firms that cross-list in the United States enjoy a significant cross-listing premium, even after the Sarbanes-

Oxley Act; London listing provides no premium).

688 Armour et al.

harm the competitiveness of U.S. markets and U.S. firms.6In contrast, the United Kingdom

is conventionally thought to be less litigious, but not un-litigious.7

The need to study private enforcement is obvious, but only a handful of previous

studies have done so, probably because of the considerable difficulties involved in data

collection. This article presents new evidence, based on hand-collected data sets from the

United Kingdom and the United States, on the number and outcome of lawsuits brought

against directors of publicly traded companies under corporate law.8Our study is, we believe,

the first comparative quantitative analysis of the private enforcement of corporate law.

The United Kingdom and the United States stand out as good choices for such a

study. Both are common-law jurisdictions with strong judiciaries, low levels of government

corruption,9and highly developed stock markets.10 In both, most large business enterprises

are publicly traded and many lack a blockholder large enough to exercise continuous,

detailed oversight of management.11 Hence, in the United States and the United Kingdom,

6Michael R. Bloomberg & Charles E. Schumer, Sustaining New York’s and the US’ Global Financial Services

Leadership (2007), available at 〈http://www.senate.gov/~schumer/SchumerWebsite/pressroom/special_reports/

2007/NY_REPORT%20_FINAL.pdf〉; Committee on Capital Markets Regulation, Interim Report of the Committee

on Capital Markets Regulation (2006), available at 〈http://www.capmktsreg.org/research.html〉; Joseph A. Grundfest,

The Class-Action Market, Wall St. J., Feb. 7, 2007, A15 (op-ed) (securities fraud class actions are “an expensive,

wasteful and unnecessary sideshow”); Peter J. Wallison, Capital Complaints, Wall St. J., Mar. 20, 2007, at A19 (op-ed).

On the possible effect of the Sarbanes-Oxley Act on corporate risk taking, see Kate Litvak, Defensive Management:

Does the Sarbanes-Oxley Act Discourage Corporate Risk-Taking? (Working Paper, 2009, available at 〈http://

ssrn.com/abstract=994584〉.

7Bloomberg & Schumer (2007), supra note 6, ex. 20 (63 percent of respondents to survey on New York’s status as a

financial center thought the United Kingdom was less litigious than the United States; 17 percent thought the United

States less litigious; 20 percent thought the two about the same); Coffee (2007), supra note 5, at 266–68; Peter

Montagnon, The Cost to Europe of America’s Class Action Addiction, Fin. Times, Jan. 5, 2007, 15 (“UK shareholders

find themselves less inclined to sue companies”).

8By “publicly traded,” we mean companies that are listed, and traded, on a stock exchange. Such firms are often simply

called “public” companies in the United States; however, in the United Kingdom, “public” companies refer to

companies formed as plcs, and thus eligible to become publicly traded—only a small minority of which in fact are. In

the United Kingdom, companies traded on the London Stock Exchange are usually referred to as “listed” or “quoted.”

The term “publicly traded” is chosen for its intelligibility to readers from either jurisdiction.

9The United States and the United Kingdom score well on most measures of legal quality, and also score very similarly,

including: efficiency of the judicial system (10 out of 10 for both), rule of law (10 for the United States and 8.57 for

the United Kingdom), corruption (9.10 for the United Kingdom and 8.63 for the United States), risk of expropriation

by the government (9.98 for the United States and 9.71 for the United Kingdom), and risk of contract repudiation

by the government (9.98 for the United Kingdom and 9.00 for the United States). La Porta et al., Law and Finance

(1998), supra note 2, at 1140–43.

10Over 1998–2007, the United States and the United Kingdom had mean ratios of stock market capitalization to GDP

of 1.43 and 1.52, respectively, compared with a world mean of 0.99 and an OECD high-income country mean of 1.09.

World Bank, World Development Indicators (2008), available at 〈http://www.worldbank.org〉.

11See La Porta et al., Corporate Ownership Around the World (1999), supra note 2, at 497 (“in the United States and

theUK...[even medium-sized] firms remain mostly widely held”). John Armour, Brian Cheffins & David Skeel,

Corporate Ownership and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, 55 Vand. L. Rev.

1699, 1704, 1715, 1750–52 (2002). Cf. Clifford G. Holderness, The Myth of Diffuse Ownership in the United States,

22 Rev. Fin. Stud. 1378 (2009) (U.S. public firms are on average no more diffusely held than in many other countries,

but ownership of U.K. firms is the most diffuse in the world).

Private Enforcement of Corporate Law: United Kingdom vs. United States 689