Information and Deterrence in Shareholder Derivative Litigation

Shareholder derivative litigation is often critiqued as costly to firms Special litigation committees have been devised as a means to dismiss low-value lawsuits and reduce unwanted litigation. This article presents a formal model which operationalizes the most common critiques of shareholder derivative litigation including meritless suits, value-decreasing suits, and self-interested plaintiffs’ attorneys who do not internalize the costs of litigation. Within this framework, allowing even an unbiased special litigation committee with superior information about suit quality to dismiss litigation may nevertheless decrease the value of the firm because it undercuts the firm’s ability to commit ex ante to an aggressive litigation stance regarding fiduciary breaches. Whether this is the case turns on firm-specific variables, such as transparency, the risk of management distraction caused by litigation, and sensitivity to small-scale managerial malfeasance, suggesting that a private-ordering approach to derivative litigation may be desirable.