Throughout the 2010s, the Supreme Court of the United States has enforced contractual provisions that force arbitration of disputes and ban class actions. Unsurprisingly, companies quickly went on to instill these mandatory arbitration provisions in their contracts with consumers, employees, and suppliers. A heated debate ensued, bursting out of academic circles and into popular media, over the desirability of such mandatory arbitration revolution. Proponents argued it will improve efficiency, by streamlining dispute resolution and reducing lawyer fees. Opponents argued it will be unfair for the already disadvantaged workers, consumers, and suppliers, depriving them of their day in court. Yet the existing debate too often misses the forest for the trees. Instead of analyzing fairness and efficiency toward parties to a given dispute, we should focus on effects on the market overall.

Public enforcement affects reputations too. The Securities and Exchange Commission (SEC) enforcement actions, in particular, play a key role in shaping the behavior of publicly traded companies. Much like with private litigation, SEC enforcement shapes behavior not just through imposing fines but also through producing information. This chapter examines how effective SEC enforcement practices are in generating valuable information and facilitating reputational sanctioning. Switching our focus from Delaware litigation to SEC investigations enriches our understanding of the law-and-reputation theory and illustrates its broad applicability. Most notably, we learn how regulatory enforcement actions generate different reputational dynamics than private litigation.

How does corporate law work? This question has puzzled corporate legal scholarship for decades. The puzzle stems from the apparent lack of legal sanctions. Corporate decision makers practically never pay out of pocket for their misbehavior, so presumably the law lacks teeth. An influential strand of the literature suggested that corporate law’s teeth consist in facilitating nonlegal sanctions. But so far the existing accounts have failed to develop a satisfactory theory of how nonlegal forces work or how exactly the law facilitates them.

Five years after the Polinsky and Shavell article that we opened the book with, the movie Spotlight came out. Spotlight won the 2015 Oscar for best film by telling a compelling story about investigative reporters holding the Catholic Church to account over child sex abuse. Yet as I was watching the movie, I could not help but see law-and-reputation themes in almost every scene. The Boston Globe’s Spotlight reporters could not have done it alone. The legal system helped them. The Globe reporters spotted the pattern of abuse by looking at numbers of lawsuits filed against individual priests. They revealed the cover-up by getting internal church documents from motions attached to court files. Spotlight is therefore not really a story about investigative journalism holding the powerful to account. It is rather a story about interactions between the media and the courts. Between law and reputation.

Reputation matters. Companies invest vast resources in building and maintaining a good reputation. And the threat of losing reputation once bad news about the company breaks disciplines corporate behavior to begin with. Companies anticipate that the release of damning information about them may raise the costs of financing, because investors and lenders now realize that the company has poorer internal controls than they had previously thought. Or it may raise the operational costs of the company, because consumers, suppliers, and employees now perceive the company’s operational culture to be more opportunistic than they had initially assumed.

Back in 2009 when I was starting my doctoral studies, I sat through my first ever law and economics seminar. Two of the field’s founding fathers – Polinsky and Shavell – were presenting their proposal to abolish product liability. A heated debate over the outcomes ensued in the room: how abolishing liability could affect access to justice or distribution. But I was still stuck on the logic, namely, how Polinsky and Shavell treated reputation as an alternative to the legal system. Manufacturers, their argument went, will invest in the quality and safety of their products even without the threat of legal liability, simply because they care about maintaining their reputation. And in markets where these nonlegal (reputational) forces are strong enough, it is not cost-effective to keep a costly adjudication system merely for the sake of an incremental contribution to deterrence.

Why do business companies donate to charity? Why do some companies donate more than others? The prevalent answers to these questions usually invoke reputation: companies donate in hope of securing good reputation among their stakeholders, or so the argument goes. Yet, the same problem we observed with the conventional wisdom on reputational sanctions appears here as well, with the conventional wisdom on reputational rewards: all too often legal scholars simply assume that donating to charity boosts a company’s reputation, without fully examining how reputational rewards work, or how the legal regime influences companies’ reputational incentives to donate.

Chapter 1 revolved around the question of why similar behaviors lead to different reputational outcomes. This chapter suggests that a large part of the answer is the legal system. When stakeholders hear about a good or bad deed done by a company, they update their beliefs about the company’s quality and consequently update their willingness to interact with the company. But this process of belief revision – the process of reputational rewarding/sanctioning – does not operate in a vacuum. The legal system generates new pieces of information on the behavior in question and adds saliency and credibility to existing information. Stakeholders can then rely on the information that was generated by the legal system to reassess their beliefs about the company. In other words, the law dictates the market reaction.

Throughout this book we have looked at examples from prizewinning journalistic stories that were told with the help of legal sources. But we have not looked at stories that were not told. What about stories that were not told because the legal system held information back, stonewalling journalists? We usually get a peek at such counterfactuals in cases where the information eventually gets out, after being buried for a while.

Can judicial review effectively check regulators’ behaviors? The answer largely depends on how regulators behave – what motivates them. If, as in traditional economic theory, regulators mostly maximize their narrow self-interest, then there is little that judicial review can do to stop regulatory capture. Judges may invalidate specific regulatory decisions after the fact, but they cannot overcome the inherent advantages that special interests enjoy in the way of offering lucrative future business opportunities or campaign financing. If, however, regulators care not just about material incentives, but also about their reputation, then judicial review can shape regulators’ behavior indirectly, by providing information on how regulators behave. Regardless of whether courts intervene and strike down specific regulatory decisions or not, the process of litigation can generate reputational pressures that propel the regulators to change their behavior.