June 2007 Vol. 105 No. 8 THE REVIEW

Rewarding Outside Directors

Assaf Hamdani & Reinier Kraakman

While they often rely on the threat of penalties to produce deterrence, legal systems rarely use the promise of rewards. In this Article, we consider the use of rewards to motivate director vigilance. Measures to enhance director liability are commonly perceived to be too costly. We, however, demonstrate that properly designed reward regimes could match the behavioral incentives offered by negligence-based liability regimes but with significantly lower costs. We further argue that the market itself cannot implement such a regime in the form of equity compensation for directors. We conclude by providing preliminary sketches of two alternative reward regimes. While this Article focuses on outside directors, the implications of our analysis extend to other gatekeepers as well.

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