Research Handbook on the Economics of Corporate Law
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Research Handbook on the Economics of Corporate Law

Edited by Claire A. Hill and Brett H. McDonnell

Comprising essays specially commissioned for the volume, leading scholars who have shaped the field of corporate law and governance explore and critique developments in this vibrant and expanding area and offer possible directions for future research.
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Chapter 18: D & O Insurance and the Ability of Shareholder Litigation to Deter

Sean J. Griffith


18. D&O insurance and the ability of shareholder litigation to deter Sean J. Griffith 1. SHAREHOLDER LITIGATION AND DETERRENCE Deterrence is widely recognized by legal scholars as the principal policy justification for shareholder litigation. Arguments in favor of the alternative, the compensation rationale, have been more or less dispatched, at least as regards the paradigmatic form of shareholder litigation, the 10b-5 class action, on the basis that damages awards provide meager compensation relative to investor loss and, from the perspective of diversified shareholders, amount to mere pocket-shifting.1 Instead, much shareholder litigation is justified wholly by its ability to cause corporate officers and directors, out of fear of being held liable to their shareholders, to foreswear bad acts – by its ability, that is, to deter. A significant problem with the deterrence rationale, however, lies in the fact that individual directors and officers are almost never made to pay for the consequences of their actions (Black et al. 2006). Nor, indeed, are the corporations they manage. Instead, an insurance policy typically steps in to fund losses arising from shareholder litigation. This form of insurance – Directors’ and Officers’ Liability Insurance or, simply, ‘D&O’ insurance – is purchased by virtually all public corporations in the United States in amounts sufficient to fund the vast majority of shareholder settlements. Moreover, most D&O policies cover individual directors and officers as well as the corporate entity they manage. D&O insurance thus transfers the risk of shareholder litigation from corporate defendants to a third party...

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