The Economic Theory of Derivative Actions

Abstract

This paper offers a model to formalize the economic theory of derivative actions developed during the last 30 years. From this perspective, the derivative action presents two interrelated problems. The first is how to solve the collective action problem that prevents that minority shareholders file a suit. The second is how to control the risk of collusive settlements between the defendant manager and the plaintiff’s attorney. This model identifies the fundamental tradeoffs that are implicit in these problems, as well as an optimum that could be used as normative benchmark. In brief, it argues that if the goal of derivative actions consists in increasing the shareholder’s wealth, then its policy purpose can be summarized as minimizing the sum of inefficient harms and insurance premia.

Keywords: Derivative actions, Corporate governance, Fiduciary duties

JEL Classification: K22, K41