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E-MailGeorge S. Geis is the William S. Potter Professor of Law and the Thomas F. Bergin Teaching Professor of Law at the University of Virginia School of Law. This post is based on his recent article, forthcoming in the Alabama Law Review.
Corporate information is valuable and often worth guarding. Firms must protect business strategies, and there is legitimate justification for opacity in the boardroom. At the same time, however, some information access is necessary to support sound corporate governance. If shareholders are expected to elect and monitor corporate leaders—as well as make personal investment decisions—then they must be able to muster facts about what is happening at the firm.
One can imagine a regime where corporate lawmakers leave decisions about information exchange solely to the private parties. Equity investors might negotiate initial disclosures and ongoing promises of information transmission at the outset of a relationship, akin to the various obligations that are standard in debt contracts. Absent a contractual right, information would remain private unless a firm’s managers found it in the corporation’s self-interest to voluntarily share additional details.
While contractual commitments of this sort occasionally play a role in corporate disclosures, we typically look to regimes beyond contract law to govern what must be revealed about a firm’s activities. Most of the focus centers on federal securities regulation. The Securities Act of 1933 and the Securities Exchange Act of 1934 establish broad public disclosure frameworks. More recent laws, including Sarbanes Oxley and Dodd-Frank, follow a similar strategy of mandating additional disclosures for many firms. Typically, these requirements are immutable and cannot be limited by private agreement. Accordingly, much of the academic literature on corporate information debates the wisdom and efficacy of imposing mandatory public disclosures in various contexts.
There is another legal option, however, for a shareholder who seeks corporate information without an explicit contractual right or public disclosure entitlement. Corporation statutes in every state include a provision that allows shareholders to privately inspect the “books and records” of their firm. There is also a parallel common law right to obtain corporate information via inspection. These laws have existed for centuries, but private shareholder inspection rights have garnered only limited academic attention. Most historical commentary discounts the likelihood that shareholders will pursue private information gathering because the efforts seem too limited, too expensive, or too unpredictable.
Recently, however, shareholders have started to initiate private inspection claims with new vigor. These demands are typically brought in connection with a shareholder grievance about some other matter. Firm managers often resist the intrusion, leading to some blockbuster disputes. Indeed, it is becoming increasingly clear that information litigation is starting to play a much greater gatekeeping role for corporate governance problems. There are often serial litigation battles where a fight over access to firm information is followed by a fight over the primary governance concern. Delays associated with the initial information lawsuit can even stymie resolution of the primary case.
Notwithstanding this increase in information litigation, lawmakers lack a comprehensive theory for evaluating the private right to corporate information. Many courts and commentators offer only short statements about a need for balance: shareholders should be able to obtain information necessary to exercise their rights, but they should not be able to harass managers or expose crucial corporate secrets. Legal standards for adjudicating private, ex-post information demands are vague. Most disputes are decided by asking whether the requested information is “necessary and essential” for pursuing a “proper shareholder purpose.” But how should we award and scope this right?
In Information Litigation in Corporate Law, I argue that inspection rights are best justified in connection with efforts to mitigate managerial agency costs through forensic review. Much of corporate law seeks to maximize the benefits of centralized economic activity while minimizing the costs of suboptimal agent decision-making. Endless varieties of agency problems exist, but the distortions are all grounded in information asymmetry. Shareholder inspection rights are thus well-suited to addressing agency lapses, and they are warranted in connection with this fundamental aim.
An important corollary to this claim, however, is that shareholder inspection rights may not be a fundamental entitlement when deployed more broadly. Recently, for example, shareholders have started to make sweeping information demands in connection with purported efforts to value their stock. Such requests have sometimes been permitted in the past. But demands for detailed forward looking corporate information should be treated with more caution. Invoking the right magic words—like “I want to value my stock”—should not automatically open the doors to sensitive prospective corporate data. Inspection rights are best used to uncover (or refute) specific allegations of a possible governance abuse, not an open-ended invitation to harvest forward looking information. If this is true, then ex-ante efforts to limit some shareholder inspection rights via private ordering in the key corporate documents might fit comfortably with the goals of corporate law.
The complete article is available for download here.
