Sunday, April 15, 2012
How Collective Settlements Camouflage the Costs of Shareholder Lawsuits, by Richard Squire, Fordham Law School, was recently posted on SSRN. Here is the abstract:
Settlements of shareholder lawsuits suffer from a collective action problem. Public corporations insure against liability by buying tiered coverage from multiple liability insurers, with each insurer covering a different slice of the potential damages in shareholder lawsuits. Current law, however, requires that any lawsuit settlement be a single resolution that collectively binds the defendant and all of its insurers. This combination of segmented coverage and collective settlements produces a conflict of interests: some insurers are better off if a case goes to trial, while other insurers — and the corporation’s managers — are better off if it settles pre-trial for the expected damages. To overcome this obstacle to settlement, courts often require an insurer to pay its full policy amount when the plaintiff makes a settlement demand that exceeds that amount and another insurer (or the corporation) is willing to pay the rest. This “duty to contribute,” encourages plaintiff overcompensation at the insurer’s expense, leading to overpriced liability insurance, lawsuits of doubtful merit, and insurer underspecialization. These costs would be avoided if settlements were de-collectivized, with the corporate defendant and each insurer able to settle separately with the plaintiff. Yet corporate managers probably prefer the status quo. By overcoming insurer resistance to pre-trial settlement, collectivized settlements shield reported corporate earnings — and the managers' incentive-based pay — from the impact of large settlement payments in shareholder lawsuits.