Predictive Ability of Directors’ and Officers’ Liability Insurance Coverage for Class Action Lawsuit Settlements

Abstract

The primary conclusion from prior literature is that firm size, as a measure of firm resources and capacity to pay, is a key predictor of class action securities settlement amount, and the merits of the case are less important in settlement negotiations. The purpose of this study is to shed additional light on the settlement determination process: given defendant incentives to avoid paying out of pocket and plaintiff incentives to settle quickly with maximum settlement, does directors’ and officers’ (D&O) insurance coverage limit explain variation in settlement amounts? I find that D&O coverage limit has predictive ability for settlement size, even when controlling for firm size. I also find that the association depends on the level of coverage; high D&O coverage has stronger explanatory power for settlements than low coverage, presumably due to the marginal benefits of plaintiff attorney effort at high levels of coverage to yield the big payoff. In sum, this paper contributes to the existing literature on predicting class action securities lawsuit settlements, which even though D&O coverage levels are unobservable to investors, impacts decision-making important to shareholders.

Keywords: Accounting, Securities Litigation

JEL Classification: K4, M4