Disclosure Norms

Eric L. Talley, Columbia Law School


Within much of law and economics scholarship, it is commonly assumed that legal regulation and extra-legal norms represent "policy substitutes" for one another: That is, society faces a choice between regulating individual behavior by using legal rules on the one hand, or by depending on non-legal deterrents (such as reputational concerns, threats of dissipative punishment, or acquired tastes for cooperative play) on the other. Furthermore, this common wisdom asserts, when courts are prone to committing significant errors, this policy choice generally cuts in favor of preferring norms over law; consequently, severely error-prone courts should relax - or even eliminate - legal liability in order to permit less error-prone norms to operate unimpeded. This paper challenges the generality of this common wisdom, using a simple game-theoretic framework of market disclosure by privately-informed parties. Within this framework, I demonstrate that the relationship between optimal legal rules and extra-legal norms is somewhat more complex than many commentators appreciate. While norms and law can certainly serve as policy substitutes on some dimensions on which they operate (such as the size of their respective sanctions), the two phenomena may actually be complements of one another on other dimensions (such as instances that determine when sanctions are triggered to begin with). As such, a society with error-prone courts and a healthy system of extra-legal norms may, ironically, adopt more aggressive set of legal regulations than would a similarly situated society where norms are weak or nonexistent. The article applies this argument to a number of corporate and commercial contexts, focusing particularly on "safe harbor" doctrines within securities fraud and warranty law.