“Comply Or Explain”—A Flexible Mechanism to Countervail Behavioral Biases in M&A Transactions

Mergers and acquisitions (M&A) are a common phenomenon of great importance in today’s business world. However, the majority of them fail to achieve the aspired objectives. These failures can be attributed to various circumstances, inter alia decision-makers’ vulnerability to behavioral biases due to the complexity, uncertainty, and time pressure characteristic of M&A transactions. Such biases often lead to predictable irrational behavior resulting in momentous misjudgments. Despite numerous psychological studies proving that people systematically tend to make irrational decisions under uncertainty, neither the transactional practice nor its current legal framework address this problem. Instead, the present law shields decision-makers from potential liability through the business judgment rule leaving shareholders largely unprotected in order to preserve the freedom of good faith business decisions. While upholding this freedom the article suggests the implementation of a best practice framework containing feasible strategies—several of which are developed in the article—against irrational behavior. This framework shall be enforced through a “comply or explain” mechanism imposing liabilities for nonobservance. “Comply or explain,” meaning that companies may choose whether to comply with the framework’s recommendations but have to publicly explain their reasons for noncompliance, is a regulatory approach adopted by several European corporate governance codes. Contrary to common legislative “one size fits all” mechanisms, it ensures maximum flexibility and minimizes interference with the business judgment itself. * Associate in the Hamburg office of Freshfields Bruckhaus Deringer LLP; LL.M., Yale Law School, Ph.D. (Dr. iur.), EMBA, University of Muenster, Germany. I would like to express my deep gratitude to Gesa Beckhaus, Lennart Beckhaus, and Richard Brooks for their thoughtful and valuable comments.