Really criminalizing agency costs

Larry Ribstein, Tom Kirkendall, and yours truly have often complained about the tendency in the United States to criminalize agency costs. As bad as things are in the US, however, they're about to get a lot worse in New Zealand where they are literally going to criminalize breaches of fiduciary duty:

The Companies and Limited Partnerships Amendment Bill has been introduced in Parliament: see here. One of the purposes of the Bill is to criminalise breaches of two of the duties owed by directors under the Companies Act (1993), by inserting the following new section (138A) in the 1993 Act:

(1) Every director of a company who does an act, or omits to do an act, in breach of the duty in section 131 (duty of directors to act in good faith and in best interests of company) commits an offence if he or she knows that the act or omission is seriously detrimental to the interests of the company.
(2) Every director of a company who does an act, or omits to do an act, in breach of the duty in section 135 (reckless trading) commits an offence if he or she knows that the act or omission will result in serious loss to the company’s creditors.
(3) A person who commits an offence under this section is liable on conviction to the penalties set out in section 373(4).”

An explanatory note for the Bill is available here.

This strikes me as literally insane. The criminalization of fiduciary duty will radically increase the sanctions faced by corporate executives. The problem is that business decisions rarely involve black-and-white issues; instead, they typically involve prudential judgments among a number of plausible alternatives. Given the vagaries of business, moreover, even carefully made choices among such alternatives may turn out badly.

If prosecutors, judges, and juries are unable to distinguish between competent risk taking and criminal mismanagement, however, the threat of criminal sanctions may discourage managers from taking risks.

Yet, risk-taking is precisely what shareholders want managers to do. As the corporation's residual claimants, shareholders don't get paid until all other claims on the corporation are satisfied. Because risk and return are positively correlated, the high returns on corporate investment necessary to leave something for the shareholders require high risks.

The problem of criminalizing agency costs should now be apparent. Obviously, shareholders want managers who steal from the company or defraud investors to be punished. Yet, they also want managers to take risks. If prosecutors and juries can't tell the difference between the two, however, criminal sanctions will leave shareholders worse off by making managers more risk averse.