Abstract
The recent financial crisis revealed enterprise risk management (“ERM”) failures while pushing us to reflect on why internal corporate governance mechanisms (“internal mechanisms”) cannot work themselves. This thus highlights a risk governance issue: which corporate governance mechanisms can effectively make ERM function? Since internal mechanisms cannot work themselves, we turn to external corporate governance mechanisms (“external mechanisms”). Specifically, in response to the financial crisis, the US aims to address the gap in risk governance through organizational reforms such as those provided in the Dodd-Frank Act that altered the structure and composition of the board of directors to further strengthen board independence. Nevertheless, such ex ante legal strategies as these legal reforms did not respond to shortcomings in the risk governance, namely, the influence of cognitive biases and structural dynamics on board decision-making processes. Others instead have suggested that an alternative important way of external mechanisms to limit corporate risk-taking lies in stricter enforcement by the courts of the board’s duty to monitor the company’s exposure to risk. In concrete terms, such ex post legal strategies as oversight liability underlies the plaintiffs’ claim in In re Citigroup Inc. Shareholders Derivative Litigation (2009). Some scholars propose to expand director oversight liability for ERM failures, beyond the original applications of compliance with existing legal and regulatory obligations prior to the financial crisis. This article, from an economic perspective, countenances the ruling of Citigroup that in order not to be contrary to all the strong policy arguments underlying the business judgment rule, director oversight liability should not be expanded for ERM failures. This article, by searching for ways to address the gap in risk governance, demonstrates that as either ex ante or ex post legal strategies have their own limitations, it’s not easy to alleviate the risk of managerial misconduct by relying only on one of the corporate governance mechanisms. Therefore, we need to realize that all corporate governance mechanisms are required to be viewed as a whole, with each of them reinforcing and closing gaps left by others so as to mitigate agency problems.