The Tournament at the Intersection of Business and Legal Ethics

Abstract

Prepared for a symposium on the role business and legal ethics played in the Enron, WorldCom, and other recent corporate governance scandals, and the relationship (if any) between business ethics and the legal profession's rules of professional responsibility, this paper examines the changes effected by Section 307 of the Public Company Accounting Reform and Investor Protection Act (popularly known as the Sarbanes-Oxley Act). Section 307 commanded the Securities and Exchange Commission to develop rules of professional conduct for lawyers appearing and practicing before it. The paper argues that Section 307 and the SEC's rules thereunder do too little to address the strong incentives lawyers have to refrain from antagonizing the corporate managers who hire and fire them. The paper uses tournament theory to explore the incentives of lawyers in large corporate law firms and in-house legal departments. (The paper is deliberately agnostic on the much debated question of whether tournament theory is a valid model or simply a useful metaphor.) Lawyers who win the tournament develop a set of skills, attitudes, and cognitive biases that systematically skew their analysis of client conduct. Hence, both rational choice theory and behavioral economics predicts that such lawyers will turn a blind eye to client misconduct.