Cox, James D. and Thomas, Randall S., Addressing Agency Costs Through Private Litigation in the U.S: Tensions, Disappointments, and Substitutes (August 26, 2015). Vanderbilt Law and Economics Research Paper No. 15-20. Available for download at SSRN: http://ssrn.com/abstract=2651863

“Many scholars argue that over the past seventy years, shareholder representative litigation has acted as an important policing mechanism of managerial abuses at U.S. public companies. Different types of representative litigation have had their moment in the sun – derivative suits early on, followed by federal securities class actions, and most recently merger litigation – often producing benefits for shareholders, but posing difficult challenges as well. In particular, the benefits are qualified by another concern, the litigation agency costs that surround shareholder suits. This form of agency costs arises since the suits are invariably representative with no requirement that the named plaintiffs have a substantial ownership interest in the corporation, so that their prosecution could be easily seen as lawyer-driven. And that perception is further underscored in the U.S. where the “American Rule,” in contrast to the “Loser Pays Rule,” provides no governor on the suit’s initiation and prosecution.  In this article, we assess the interactions of shareholder suits and governance mechanisms. Our thesis is straightforward: we claim that the recent rise of some important governance developments is a natural consequence of both the ineffectiveness and inefficiency of private suits to address certain genre of managerial agency costs. That is, just as one part of a balloon expands when another part contracts, we find that governance responses evolve to fill voids caused by the decompression of shareholder monitoring once supplied by private suits. In other words, as representative shareholder litigation comes under increasing attack, greater attention needs to be devoted to governance and market mechanisms as alternative means to address managerial agency costs.”