Shareholder Litigation: Reexamining the Balance Between Litigation Agency Costs and Management Agency Costs

Abstract

Shareholder lawsuits are a principal legal means to control management agency costs in corporations, yet they generate their own agency costs from the attorneys who bring representative litigation. The key policy question, and one that is central to good corporate governance, has long been how to properly balance the positive management agency reductions from shareholder litigation against the often-maligned litigation agency costs. We address the tradeoff inherent in this debate using our empirical study of shareholder litigation in Delaware. Our data set of all 1000 corporate fiduciary duty cases filed in Delaware in 1999 and 2000 is the largest empirical study of shareholder litigation. We find that more than 80% of these cases are class actions against public companies challenging one type of director decision - whether or not to participate in a corporate acquisition. By contrast, derivative suits, the traditional shareholder litigation that is the staple of corporate law casebooks, make up only about 14% of all fiduciary duty suits. The acquisition-oriented class actions are a new, previously unstudied category of representative litigation, an area long dominated by studies of state derivative suits and federal securities fraud class actions. We find these suits do provide some management agency costs reductions, but these are concentrated in only one subset of the suits that are brought. Settlements leading to relief in an acquisition setting are not spread across all acquisitions complaints (including hostile, second bidder acquisitions etc.), but rather concentrated where there is a majority shareholder who is attempting to cash-out the minority interest held by public shareholders on terms that have been picked by the majority. On the opposite side of the equation - whether these suits possess high litigation agency costs - we find conflicting evidence. The acquisition oriented class action suits have many characteristics that have been identified in other contexts as indicators of agency costs (e.g., suits filed quickly, many suits per transaction). Yet, these litigation agency costs are below the level of perceived costs that spurred securities fraud legislation, for example. We suggest that Delaware could reduce the litigation agency costs associated with class actions without increasing management agency costs by instituting two procedural reforms. First, Delaware should enact a lead plaintiff provision, similar to that adopted for federal securities fraud class actions in PSLRA, to encourage larger investors to become more active monitors of fiduciary duty litigation. Second, we suggest that Delaware should put in limitations on professional plaintiffs as in PSLRA in order to reduce litigation agency costs further. Our article also examines derivative lawsuits from the two-year period, but we find that they do not look much like our acquisition cases (e.g., longer time to file and to settle, fewer suits per transaction and more motions). Derivative cases in our database are concentrated in areas where management agency costs seem likely to be high and produce a number of beneficial settlements that are concentrated in duty of loyalty contexts. Given these characteristics and the current balance between reducing management agency costs and increasing litigation agency costs in derivative litigation, we suggest that Delaware could loosen some of the restrictions that it has placed on shareholder plaintiffs in derivative cases.