Introduction

In corporate law, directors are considered the agents of the company and thereby occupy a fiduciary position which obliges them to act in its best interests. The Business Judgement Rule (BJR) emerged as a judicial doctrine in Delaware, United States to provide protection to directors while discharging their duties. Recognising the need to protect directors from liabilities for decisions made in good faith, Delaware devised this doctrine in the light of increasing fear of litigation due to business risks and uncertainties associated with it. BJR is not absolute; there are exceptions to this rule which include fraud, illegality, conflict of interest, etc. Moreover, the doctrine was formulated in the context of corporate structure existing in the United States.

In India, the fiduciary duties of directors are codified under Section 166 of the Companies Act, 2013 which mandates directors to put the company’s interests in priority and exercise their duties with due care and diligence. Various duties have emerged from this provision like fiduciary duties of directors, not involving in diversion of corporate opportunities, exercising proper purpose rule. In considering whether such doctrine should be formally incorporated in India or not needs a thorough consideration of India’s corporate realities. While BJR in the Indian context has been talked about to a great extent, this article does not go into its legal depths. Instead, it argues that BJR, as developed in the United States (U.S.), should not be imported directly into Indian corporate law without studying the Indian market first and adapting it accordingly. Drawing on Enlightened Value Maximization (EVM) theory developed by Michael C. Jensen, a professor at Harvard Business School, this article seeks to use the theory to present an integrated approach by combining BJR with Enlightened Value Maximization to promote both innovation and protect stakeholders’ interests.

Risk Aversion Factors in BJR

The Business Judgment Rule plays an important role in protecting risky business decisions taken by directors. Two dominant models are relevant here – shareholder wealth maximisation and financial value maximisation.

Under the shareholder wealth maximisation model, the company’s primary goal is to enhance shareholder value. This model aligns with the traditional understanding that directors’ fiduciary duties are owed primarily to shareholders. The fiduciary duties owed to the shareholders stemmed from the decision in Dodge v. Ford Motor Co where the traditional understanding of “shareholder fidelity” was adopted on the presumption that “what is good for the corporation is good for the shareholder.”

On the other hand, financial value maximisation is a broader term which focuses on stakeholders’ interests and aims to achieve a higher value for all the affected people, including creditors, employees, etc. This model becomes especially relevant during insolvency, where the focus shifts to preserving the company’s value to satisfy its debts. Without protection to directors, there would be heightened litigation risks especially from creditors during the “zone of insolvency” which would prevent directors from effectively managing company’s assets. Thus, BJR got expanded and didn’t remain limited to serving shareholders only, which would give directors greater latitude to take risky decisions without fear of liability.

BJR, apart from giving protection to the directors, also help them to take up business risks as long as business decisions are made in good faith. This will facilitate value creation and long-term planning. This also in part depends on the level of risk that shareholders are willing to take. There has been quite a debate whether BJR should be codified or not. Some have claimed that it is really context dependent, and the BJR, as formulated by the Delaware courts, should not be imported in stricto sensu and each country should study their market, investor behaviour, capital developments, etc. Though shareholders have limited liability in the company, yet the dividends they receive are dependent on the returns the company gets, which in turn can get affected if any project fails. Therefore, studying the shareholder’s behavioural patterns and risk preferences provides valuable insight into the corporate governance structure in a given jurisdiction.

In the United States context, the shareholders are not risk averse, and they prefer high-risk, long-term investments. Thus, there was a need to come up with the concept of BJR in the United States to encourage innovation and simultaneously give protection to directors for risks they undertake in business operations. Thus, BJR became associated with promoting innovation and growth.

Whether the BJR should be codified or not is highly dependent on the companies’ structure in India and the real priorities of the shareholders and stakeholders in such companies. If focussing specifically on shareholders’ interests, as the traditional conception of BJR focuses primarily on these shareholders, it will be seen that shareholders in India tend to depict a behaviour of risk aversion and are more willing to create a higher value for their investments in the short run, instead of undertaking risky ventures which might affect their future earnings. Empirical and behavioural studies have shown that “loss hurts more than reduction in profits”, showing that investors are hesitant to take up risks rather than to gain potential profits. Indian investors are not considered as ‘neutral’ in their dealings with the company, and they prioritise stable returns over long-term, speculative high-risk ventures. Hence, Indian shareholders are less likely to approve a resolution where high risks are involved. They prefer safer projects and as a result, BJR, which shield directors from liability while taking risky decisions, might take such legal protection as a green signal to undertake risky and speculative deals, going against the essence of shareholders primacy.

Therefore, BJR cannot simply be transposed from U.S. to India without understanding the corporate governance structure in India. Though, it is now being adopted in many jurisdictions, the specificities and peculiarities of the Indian context needs to be taken into consideration by the legislation before any general assumptions can be made about it.

Interconnecting Enlightened Value Maximisation and Business Judgement Rule

Michael C. Jensen, professor at Harvard Business School, proposed a model called Enlightened Value Maximization (EVM), which is also called as “enlightened stakeholder theory”. This model focusses on creating long-term goal of increasing the value of the company by keeping in mind the interests of all stakeholders. This model acknowledges that stakeholders like customer, suppliers, communities, employees, etc. play a major role in making a company grow.

Unlike traditional stakeholder theory which solely focuses on considering other stakeholders’ interests, Jenson brings all such interests down to a common metric – long-term value of a company. Enlightened value maximisation aims to maximise long-term firm value which goes beyond a mere consideration of stakeholder’s interests. EVM recognizes the “trade-offs” that happen between different stakeholders within a company. This model uses the traditional financial value maximisation or even the stakeholder theory but goes one step beyond to substantiate that “trade-offs” between these competing groups in a company should be resolved by fixating everyone’s goals and objectives to long term maximisation.

The inherent assumption underlying such theory is to figure out how to handle miscommunications within the organisation and how to balance every stakeholder’s interests. Therefore, to come at a common ground, there is a need to consider value maximisation as a “scorecard” of an organisation so that everyone in the corporation have a guiding path to follow with a coherent, long-term objective in mind. Also, Jenson emphasises on the role each stakeholder plays in a company as without one, the company will not be able to realise its goals effectively.

For directors to assess the long-term future of a company, they are given discretionary powers and here is precisely where BJR is needed the most. The basic premise of EVM rests on the assumption that it will help in “resisting the temptation to maximize the short-term financial performance” as having a parochial focus on short-term profits can hamper the long-term value of a company. Therefore, EVM complements the BJR model by providing directors the latitude to focus on long-term interests of the company rather than be influenced by risk aversive behaviour of the shareholders.

In the United Kingdom, Section 172 of the UK Companies Act 2006 talks about “enlightened shareholder theory”. Enlightened stakeholder theory is different from the enlightened shareholder theory where the later focuses on putting the long-term value in mind as a means to an end, the end being to maximise the value for the shareholders. However, EVM focuses on creating long-term value for the entire corporation, which entails more than just “acceptance of value maximisation” and instead aims to create a sense of obligation among its employees, managers to consider the long-term value of the firm as the “basic criterion”.

BJR helps directors to take on risky ventures without fear of judicial intervention, provided it is done in good faith. However, this comes as a challenge in India where shareholders exhibit risk aversive behaviour. Such behaviour might dissuade directors from taking any innovative projects and will not be able to work effectively for long term progress of the company due to fear of litigation suits. Though both BJR and EVM are developed in the United States and has not been codified in India, EVM can mitigate some of the gaps that BJR has when applied in the Indian context. The prevention of “trade-offs” can ensure directors do not sideline any one stakeholder’s interests and hide behind the veil of BJR. Thus, it can promote growth while also upholding the duties that directors have towards other stakeholders. This model can make the shareholders see the long-term impact of business decisions if directors are able to adequately demonstrate the viability and profitability of the project in the long run. Hence, BJR should be modified according to the Indian context, and for this, connecting EVM with BJR can provide a good alternative to address the challenges specific to the Indian context.

Conclusion

Risk aversive behaviour of Indian shareholders, coupled with comparatively less robust mechanisms of shareholder activism and class action lawsuits in India creates a logical premise that BJR, as understood in the United States, needs to be moulded before it can be applied in India. A better alternative could be to intertwine BJR with EVM. EVM provides a normative structure for achieving long-term firm value. The benefits of EVM can act as a check against abuse of powers and prevent exercise of arbitrary discretion in the hands of the directors.

BJR should be incorporated in India with certain modifications. Through this, it can foster calculated business risks while also providing a protective shield for the directors. The courts also do not need to make any second guesses with respect to the business decisions taken; instead, adopting EVM with BJR can enable them to focus more on the procedural parts – like director’s good faith, due diligence, their focus on long-term value – rather than substantive decision or the outcome that came about.

Moreover, risk aversive behaviour of Indian investors can be mitigated by shifting their focus on long-term value creation. This will also help in dispelling some of the trust issues that shareholders might have towards the board of a company. It will lessen the perception of directors acting solely for their own financial interests and in turn reinforcing the fundamental presumption that “what is good for the corporation is good for the shareholders.”

Therefore, Business Judgement Rule, if codified and complemented by Enlightened Value Maximisation, can strike a fair balance between shareholder value and risk-taking decisions, while also shielding the directors. This approach will be able to respond effectively to Indian corporate market and will prevent the market on becoming sluggish due to its excessive safety valve that it can create around itself because of over-cautious policies. As the Indian economy grows, there is a need to also promote innovation and entrepreneurship, while also protecting Indian investors.