Smart Contracts for Automating Corporate Governance and Contractual Compliance

Abstract

Corporate governance and contractual compliance rest on obligations, such as approvals, disclosures, covenant tests, payments and reporting deadlines, that are specified in documents and fulfilled by people, with the result that obligations are missed, delayed and expensively audited. Smart contracts, programs on a distributed ledger that execute obligations automatically when their conditions are met, promise to remove this gap between specification and execution for obligations that can be codified. This paper develops a framework for deciding which governance and compliance obligations to automate and examines three enforcement regimes in a simulation of 2,000 obligations, of which 75% are codifiable: manual compliance, rule-based workflow automation and smart-contract enforcement with manual fallback for non-codifiable obligations. Smart-contract enforcement reduces missed obligations from 206 to 64, mean delay from 5.0 to 1.3 days and cost per obligation by 45%, and raises audit completeness from 70% to 99%, but introduces 29 rigidity incidents in which automatic execution was inappropriate given circumstances the contract could not observe. Rule-based workflow captures about half the improvement without rigidity. The paper argues that the automation decision turns on codifiability, on the cost of rigidity relative to the cost of omission, and on the availability of trusted inputs, and proposes governance arrangements for the smart contracts themselves.