Litigation Risk and the Independent Director Labor Market

Abstract

After decades of declining litigation risk, independent directors of public companies are viewed as effectively immune to personal litigation costs. However, the unexpected In re Investors Bancorp decision by the Delaware Supreme Court in 2017 lowered the liability threshold only for directors in derivative litigation over their own equity grants. Investors and firms both reacted to this rare increase in director-only litigation risk. First, Delaware firms experienced significant negative short-window returns, concentrated in firms where equity compensation is most important, consistent with investor concerns about attracting and/or retaining qualified directors. Second, Delaware firms added more qualified directors to the compensation committee. Third, Delaware firms with higher abnormal compensation decreased director compensation. Finally, Delaware firms decreased discussion of director pay in 8-K filings and their use of compensation consultants. Overall, results are consistent with firms acting to mitigate litigation concerns.